Financial Stability 2/2002

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6 Financial institutions

6.1 Profits
6.2 Financial strength
6.3 The competitive situation

Box:
- Risk pricing in Norwegian banks

6.1 Profits

Weaker results

Banks’ profits have continued to decline this year. Banks’ pre-tax profits were 0.77% of average total assets (ATA) in the first three quarters of this year (Table 6.1). Banks have not recorded weaker results since 1992. The figure for the same period last year was 1.03%. The decline in profits is mainly due to lower commission income and income from securities markets. Higher loan losses have also contributed to the decline. The number of banks recording weak results has increased (Chart 6.1). At the end of the third quarter, 12 of a total of 144 banks recorded negative pre-tax profits, as against 7 banks a year earlier.

Table 6.1     Chart 6.1

Banks total net interest income was approximately unchanged compared with the first three quarters of 2001. In relation to average total assets, total net interest income now accounts for just below 2.2%. This is close to 1 percentage point lower than in the mid-1990s (Chart 6.2). On average, net interest income is highest in the small banks.

Chart 6.2

Negative developments in securities markets have reduced banks’ income from other activities. Commission income, share dividends and capital gains on securities were lower during the first three quarters of this year than in the same period last year, while exchange gains rose.

Banks’ overall operating expenses as a percentage of average total assets have been marginally reduced over the past year. There has, however, been a steady decline in operating expenses since the mid-1990s, which indicates that banks have become more cost-effective.¹

The weak developments recorded in parts of the corporate sector in 2002 have so far had little impact on loan losses. This is because most enterprises were financially very strong at the beginning of the year (Chapter 3). Banks’ recorded loan losses increased from 0.24% of gross lending in the third quarter of 2001 to 0.30% in the third quarter of this year. The number of gross non-performing loans has also risen.

Lower return on equity

Weak results have contributed to a reduction in banks’ return on equity. Return on equity for the financial groups DnB, Nordea Bank Norway and Fokus Bank was below 9%, while the Union Bank of Norway recorded a return of over 10% in the first three quarters of this year. This is substantially lower than in the same period last year, and is also lower than recorded by the largest Nordic financial groups (Chart 6.3).

Chart 6.3

6.2 Financial strength

Banks still financially strong…

Norwegian banks’ core capital ratio increased overall from 9.3% at the end of the third quarter last year to 9.5% in the same period this year. The core capital ratio in the eight largest financial groups varied between 6.8 and 8.9%. At the end of the third quarter, the largest Norwegian financial groups, with the exception of the Union Bank of Norway, had a relatively high core capital ratio compared with the other Nordic bank groups (Chart 6.3).

Chart 6.3

Moody’s rating for financial strength and long-term financing for a selection of Nordic banks is shown in Chart 6.4. The financial strength rating may be regarded as a measure of the probability of a bank needing assistance from its owners and/or a third party. The rating for long-term financing is intended to reflect the bank’s capacity to service its long-term debts as they fall due.

Chart 6.4

The largest Norwegian banks have a somewhat lower rating than several of the largest Nordic banks. The ratings nonetheless indicate that they are financially strong and that their debt servicing capacity is good or very good. The medium-sized Norwegian banks have a considerably lower rating than the three largest Norwegian banks with regard to both financial strength and long-term financing. However, according to the ratings, their financial strength is satisfactory and their debt servicing capacity is good.

In Norway, 70% of the banks have a rating indicating only satisfactory or moderate financial strength. This is a far larger share than in Sweden, Denmark or Finland. The share is also larger than in Germany, France, the UK and the US, where 66%, 60%, 58% and 52% respectively of the rated banks were listed in these groups. However, Norway has more banks above a certain minimum size than the other Nordic countries. As a result, more of Norway’s medium-sized banks have been rated by the international credit rating agencies (Chart 6.2).

Table 6.2

…but reduced financial strength in life insurance companies

Life insurance companies pre-tax result before customer awards showed a deficit of NOK 10.7bn or -3.6% of ATA for the first three quarters of 2002 compared with a deficit of NOK 9.5 or -3.4% of ATA for the first three quarters of 2001. Premium income rose and net income from financial assets was less negative than at the end of the first three quarters of 2001. This was more than offset by higher insurance provisions, however, so that the result was somewhat weaker than for the first three quarters of 2001. Capital adequacy rose from 12.2% to 15.2% from the end of the third quarter 2001 to the same time a year later. This is mainly due to a lower measurement base as a result of reallocation from high-risk equities to lower-risk bonds. The buffer capital has been reduced, and at the end of the third quarter amounted to only 2% of total assets.

The reduction in shareholdings has reduced their vulnerability to any further decline in equity markets (see box in Chapter 2). On the other hand, reduced shareholdings may limit future returns. Life insurance companies’ buffer capital must be strengthened to enable them to rebuild their shareholdings. At the end of October, no life insurance company had been granted or had applied for exemption from the capital adequacy requirement. One company had, however, applied for an extension of the temporary exemption from the solvency margin requirement. Earlier this year, three companies were granted exemption from the capital adequacy requirement for the third quarter.

Low market risk in banks, but higher credit risk

Norwegian banks’ direct exposure to developments in securities markets is relatively limited. Their shareholdings are very small, while holdings of bonds and short-term papers are somewhat larger (Table 6.3). Estimated interest sensitivity for the bond portfolio indicates that interest-rate risk in banks’ trade portfolios is low.

Table 6.3

Banks’ credit risk is considered to have risen in the past half-year (Chapter 3). Overall household debt burden is now as high as it was in the years immediately preceding the banking crisis. The corporate debt burden is also very high. However, banks’ share of loans to industries with the highest risk is relatively small (Chart 6.5). For some banks, exposure may nonetheless be high in these industries.

Chart 6.5

Banks able to absorb loan losses

Simplified calculations carried out at Norges Bank indicate that banks’ loan losses can increase markedly for several years before the risk to banks’ financial strength reaches a critical level. According to the projections, all the banks in the analysis will be able to absorb a single loss of close to 2½% or more of gross lending before their buffer capital, i.e. the difference between eligible capital and the capital requirement, is depleted. Banks will also be able to absorb a loss of 1½% or more of gross lending each year over a three-year period before the buffer is depleted, assuming that profits are the same as in 2002. At the end of the third quarter, none of the banks in the analysis had recorded loan losses of more than 0.6% of gross lending. Average loan losses for the banks in the analysis were 0.3%.

Chart 6.6

Because of their financial position, banks are well equipped to deal with more sluggish economic developments. Persistently high credit growth in a situation with a high debt burden means that both households and enterprises will face substantial demands in terms of future income growth in order to maintain debt servicing capacity. The interaction between households and enterprises in terms of real economic developments is important. Weaker household income growth leading to lower demand might result in corporate loan losses without any appreciable rise in housing loan losses. If interest margins and income from other activities continue to fall, this will exert further pressure on banks’ earnings. Overall, banks financial position is regarded as sound, although somewhat weaker than in the previous report.

6.3 The competitive situation

Market continues to be dominated by the largest banks

There has been little change in market shares for small, medium-sized and large banks over the past five years (Chart 6.7). The three largest banks still account for almost half of the loans to Norwegian households and non-financial enterprises. Small and medium-sized banks have marginally reduced their market shares, while branches of foreign banks have increased their share from 2.9 to 4.5%. The increase is mainly due to the takeover of Bergensbanken by Handelsbanken in 2001. In total, foreign-owned branches and subsidiary banks have substantially increased their share of the Norwegian loan market after Kreditkassen and Fokus Bank became subsidiaries of foreign-owned banks. At the end of the third quarter, these banks together accounted for over 21% of the Norwegian loan market.

Chart 6.7

DnB acquired Skandia Asset Management earlier this year. Nordea Bank Norway has largely sold off its non-traditional banking activities. This means that this bank, like Fokus Bank, is now more oriented towards traditional banking operations. In September, the Union Bank of Norway was converted into a limited company and listed on the Oslo Stock Exchange. The purpose of the conversion was to make it easier for the bank to raise new capital.

Little change in interest margins

There has been a marginal reduction in Norwegian banks’ interest margins over the past year (Chart 6.8). The lending margin is approximately 0.4 percentage point higher than at the end of the second quarter last year. This may be an indication that banks are now placing more importance on pricing the risk linked to their loans (see separate box). The deposit margin is almost 0.5 percentage point lower than at the same time last year. Some of the smaller Norwegian banks are perceived as relatively high-risk in the market. This means that money market financing is relatively costly. The authorities guarantee deposits up to NOK 2 million under the deposit guarantee scheme in Norway. A cheaper financing option for banks with expensive money market financing may therefore be to increase their deposit-to-loan ratio by offering higher interest rates on customer deposits. To the extent this has occurred, it may have contributed to reducing deposit margins in general.

Chart 6.8

© 2002 Norges Bank webmaster@norges-bank.no