Financial Stability 1/2002
6 Banks' financial position
6.1 Lending growth and financial strength
6.2 Banks' profits
6.3 Future prospects
6.1 Lending growth and financial strength
Banks’ lending growth appears to have stabilised the last half year at
just under 10% after having been on the decline since autumn 2000 (Chart 1.4).
Growth in lending has been somewhat higher in the three largest banks than in
small and medium-sized banks.
Chart 1.4
A reduction in lending growth has improved financial strength. Seven of the
nine largest banks reduced lending growth and improved their core capital ratio
in 2001 compared with 2000 (Chart 6.1). The three largest banks improved their
average core capital ratio in 2001 from 7.8% to 8.5%, while the average core
capital ratio for the other banks remained unchanged at 11%.
Chart 6.1
6.2 Banks’ profits
Somewhat weaker underlying earnings, …
Banks’ net interest income as a percentage of average total assets (ATA)
fell in 2001. On the whole, net interest income as a percentage of ATA was lower
at the three largest banks than at the other banks. One reason for this is that
traditional borrowing and lending activities make up a larger portion of small-
and medium-sized banks’ operations. At the same time, this means that
changes in the interest margin have more impact on small- and medium-sized banks
than on the three largest banks.
Table 6.1 Table
6.2
The overall interest margin sank to an all-time low in the fourth quarter of
2001 (Chart 6.2). The decline was caused by a fall in the deposit margin of
0.6 percentage point, which was only partially balanced by the 0.5 percentage
point rise in the lending margin. The overall interest margin in Norway is low,
even compared with countries like Sweden and Denmark (Chart 6.3).
Chart 6.2 Chart
6.3
Other operating income has over the last few years accounted for an increasing
portion of banks’ total income and has thus become more important for
banks’ operations. Uncertainty in the securities markets had a negative
impact on banks’ other operating income. Other operating income is higher
in the three largest banks than in the small and medium-sized banks, measured
in relation to ATA. However, there was a similar decline in operating income
from 2000 to 2001 in both groups of banks measured in relation to ATA, possibly
indicating that the three largest banks were better able to adapt to the changing
trends.
In 2001, banks’ operating expenses fell slightly as a percentage of ATA.
Banks are actively working to reduce labour and administrative costs by becoming
more efficient and by outsourcing certain functions. However, the increase in
other, not directly bank-related activities – such as providing estate
agency services and selling insurance products – has an opposite effect.
Overall, underlying earnings (pre-loss operating profit) were somewhat lower
in 2001 than in 2000 for both groups of banks.
… and a slight rise in non-performing loans and losses, …
After remaining at a stable, low level over the last few years, there was a
slight rise in non-performing loans as a percentage of total lending in 2001.
Corporate lending increased most. Changes in the volume of non-performing loans
may be a signal of future changes in recorded losses.
There was also a rise in recorded losses in 2001 (Chart 6.4), the greatest
increase being accounted for by the three largest banks. Recorded losses have
been low and sometimes negative in these banks over the last few years due to
reversals of previously recorded losses on loans and exposures. The rise in
losses in 2001 for the eight largest banks is mainly due to higher loan loss
provisions on new loans and a rise in actual losses that were not covered by
previous loan loss provisions (Chart 6.3).
Chart 6.4 Table
6.3
Recorded losses normally rise in the course of a year. In 2001, the rise was
particularly steep in the last two quarters (Chart 6.5). It is likely that this
increase is related to increased uncertainty and a downward revision of growth
forecasts after the terrorist attacks in the US on the 11 September last year.
Chart 6.5
Although there has been an increase in the volume of non-performing loans and
losses, it is still on a scale that can be regarded as normal. The losses are
also relatively low in relation to banks’ equity ratio.
… produced weaker results in 2001, …
Lower underlying earnings and a certain increase in non-performing loans and
losses resulted in an overall operating profit before tax that was somewhat
lower in 2001 than in 2000. The drop in operating profit was less marked for
the three largest banks than for the small- and medium-sized banks. The small-
and medium-sized banks recorded extraordinary sales gains in 2001, which contributed
to a weak profit trend from 2000 to 2001. Nonetheless, most of the banks achieved
a positive result (Chart 6.6).
Chart 6.6
… although nonetheless a satisfactory return on equity
Weaker results meant that banks’ return on equity in 2001 was lower compared
with the previous year, about 12.5 per cent for both groups of banks (Chart
6.7). Banks’ overall return on equity has been relatively good ever since
1993, even compared with large European banks. As a whole, therefore, the banking
sector can be regarded as financially strong and profitable.
Chart 6.7
Weaker results continue in the first quarter of 2002
For the banks as a whole, pre-tax profits (as a percentage of ATA) declined
in the first quarter of 2002 compared with the same period in 2001. Overall
operating profits for the three largest banks were weaker, while results improved
in small and medium-sized banks. The largest banks’ decline in their profits
was particularly due to a drop in other operating income. In small- and medium-sized
banks, other operating income increased, and this income, combined with an increase
in net interest income, enabled them to achieve better results.
In the first quarter of 2002, recorded losses in relation to ATA were approximately
the same as they were in the first quarters of 2001 and 1999. In light of the
strong increase in losses in each quarter of last year, it might be expected
that losses in the first quarter of 2002 would be higher. The relatively low
figure for the first quarter indicates that the increases in loan loss provisions
last year were sufficient to cover expected future losses, and that banks have
not found it necessary to make a similarly substantial increase in provisions
for losses so far this year.
6.3 Future prospects
Over the last few years, banks have shown good results, partly due to strong
growth in lending and low losses. An expanding market has made it possible to
increase the volume of loans and the level of activity to partially compensate
for a declining interest margin. Banks’ results largely depend on income
from traditional banking activities. The pricing of loans according to the level
of risk of financial loss undertaken by banks is particularly important for
long-term profitability. Good underlying earnings in banks are important to
financial stability because it enables the banks to use current income to cover
losses without reducing their buffer capital. It is expected that banks’
overall underlying earnings will remain at a satisfactory level and that financial
strength will be maintained.
The size of the banks’ buffer capital, that is how much capital the banks
can draw on before they reach the statutory minimum level, is also important
to financial stability. These capital buffers ensure that abnormally large losses
can be absorbed by the banks without the need for an immediate transfer of new
capital. Calculations for the eight largest bank conglomerates based on simplified
assumptions show that most of the banks have capital buffers equivalent to between
2.5 and 3.5 per cent of gross lending. On the basis of this buffer capital and
assuming that underlying earnings remain unchanged, most of the banks will absorb
annual losses of between 2 and 3 per cent of gross lending over a three-year
period before the buffers have been depleted. These loss levels are well above
the levels suggested by the stress tests in Chapters 2 and 3. In comparison,
the average loss for banks in the period 1991-93 was approximately 2.6 per cent
of gross lending.
These calculations are based on balance sheet figures for bank conglomerates
at the end of 2001 and an assumption that underlying earnings will remain at
the same level as in 2001. However, if losses increase, earnings may be reduced.
In isolation, reduced earnings will weaken banks’ capacity to absorb losses.
However, the calculations support the impression that losses can increase substantially
for several years without presenting an immediate risk to banks’ financial
strength.
Overall, the banking sector is considered to be financially sound. Equity is
high in relation to losses, especially compared with the situation at the beginning
of the 1990s. Losses would have to increase markedly to weaken stability in
the bank sector.
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