Financial Stability 2/2002

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4 Liquidity risk

Box:
- Norwegian banks' counterparty exposure

The term to maturity on banks’ borrowing in relation to the term to maturity on their claims is decisive for liquidity risk. A high level of short-term funding will represent a liquidity risk for banks if their liquid assets are not adequate. Short-term foreign financing is normally considered more unstable than short-term domestic financing. Foreign creditors may have a lower threshold for withdrawing funding in the event of uncertainty about Norwegian banks’ financial strength or uncertainty about national and international market conditions.

Somewhat higher share of short-term funding

Banks’ funding in the money and capital markets has increased through the 1990s (Chart 4.1). This is due to a prolonged decline in banks’ deposit-to-loan ratio (customer deposits as a percentage of lending to the public). The decline in banks’ deposit-to-loan ratio slowed somewhat in the beginning of 2002, but in the third quarter, it fell again. At the end of September, the deposit-to-loan ratio was 66%, a decline of 2 percentage points since March.

Chart 4.1

Banks’ funding in the money and capital markets has decreased somewhat in the last half year (Chart 4.2). Long-term funding in the bond market in particular has declined in this period, while money market financing has remained stable.

Chart 4.2

Bank’s choice of short-term or long-term funding will depend in part on the costs involved in the two types of financing. Chart 4.3 shows how banks’ bond market funding has developed in pace with the difference between short-term rates and long-term rates. In periods when bond yields are lower relative to interest rates on money market loans, banks have traditionally increased the share of bonds. Similarly, they have reduced the share of bonds in periods when the rate spread narrows. From 2001, this pattern was broken, however, when banks increased the funding in the bond market even though the spread between short and long rates narrowed through four quarters. In isolation, this adjustment contributed to reducing liquidity risk.

Chart 4.3

From March 2002, the rate spread widened sharply. Small and medium-sized banks have continued to shift to more bond funding, while the largest banks, on the other hand, have reduced the share of bond funding.

Gross foreign debt is somewhat lower

Banks’ total foreign debt has risen sharply the last few years, but has decreased somewhat in the last half year (Chart 4.4). At end-September 2002, this debt was NOK 316bn, corresponding to 27% of gross lending. The largest banks account for most of the foreign borrowing, but foreign borrowing is also fairly substantial at some other banks. At end-September, the three largest banks’ foreign debt corresponded to 42% of gross lending, down from 47% in March this year. Small- and medium-sized banks’ foreign debt is considerably lower and has been reduced in the last half year.

Chart 4.4

Short-term money market funding accounts for a large portion of the three largest banks’ foreign debt (Chart 4.5). At the same time, these banks have a relatively large share of liquid assets. Liquid assets may be used at short notice if funding dries up. Such assets may also serve as a guarantee for those lending to banks so that the risk of losing funding for this reason alone may be reduced. The share of short-term foreign funding is lower in small- and medium-sized banks and has been reduced since March.

Chart 4.5

Stable financing as a share of illiquid assets is an indicator of liquidity risk (Chart 4.6). An increasing value for the indicator reflects a reduction in liquidity risk. Risk has increased for the three largest banks and for small banks due to a higher share of money market financing, while it has declined somewhat for medium-sized banks.

Chart 4.6

Liquidity risk ahead

The three largest Norwegian banks have the best rating for short-term funding, according to Moody’s. Among the next five banks, measured by size, one bank has the best short-term rating while the rest have the second best rating.

At some banks, short-term foreign funding accounts for a large share of financing. This makes them vulnerable if refinancing opportunities abroad should disappear. The ownership structure in the banking industry has changed compared with earlier. Even if Norwegian-owned banks experienced funding problems abroad, foreign-owned banks would not necessarily experience the same. Therefore, the probability that financial stability will be weakened if foreign financing dries up for individual banks may be somewhat lower than earlier. On the other hand, the Norwegian economy may be affected if foreign parent banks encounter financing problems in their respective countries. Overall, liquidity risk is still considered to be relatively low, but somewhat higher compared with six months ago.

© 2002 Norges Bank webmaster@norges-bank.no