Financial Stability 2/2000
5 Liquidity risk
Norges Bank: Financial stability 2/2000
Box: Capital movements and their effects on financial institutions
Increased financing via money and capital markets
Growth in bank lending to the private non-financial and municipal sector has for several
years been stronger than growth in customer deposits (see Charts 5.1 and 5.2). In savings banks,
it is primarily deposits from households which have not kept pace with lending growth. From 1993
to September 2000, household deposits measured as a percentage of loans to the private non-financial
and municipal sector dropped from approximately 70% to just under 50%. In commercial banks, the total
deposit-to-loan ratio decreased in the period from 1995 to mid-1998, which was a period of strong
lending growth. Following a period of slow lending growth, commercial banks' lending growth has
again picked up. At end-September, the deposit-to-loan ratio in commercial and savings banks was
69% and 67%, respectively.
As a result of the decreasing deposit-to-loan ratio, banks to an increasing degree have had to
finance lending growth in money and capital markets. The maturity of this type of financing is
decisive for liquidity risk.
Chart 5.1
Chart 5.2
Banks' short-term debt has increased
Chart 5.3 shows developments in commercial banks' liquid assets and short-term debt.5) From 1995 to 1997, short-term debt increased sharply, particularly deposits from
financial institutions, while liquid assets remained at a stable level. Since then, short-term debt,
measured as a percentage of total assets, has decreased. In 2000, short-term debt has increased by
NOK 46 billion, from 27% of total assets to 29%. Debt to foreign financial institutions accounts
for most of this increase. At the same time, liquid assets have remained more or less unchanged.
Part of the increase in lending growth this year has thus been financed by short-term funding
from abroad. Savings banks' short-term debt has risen more or less continuously since 1995
(see Chart 5.4). The increase was particularly marked towards the end of 1999, while short-term
debt has remained at around 22% of total assets this year. Savings banks' short-term foreign
debt has remained more or less constant in nominal terms in 2000.
Chart 5.3
Chart 5.4
5) Liquid assets: notes/coins, deposits and securities (current assets).
Short-term debt: deposits and loans from domestic and foreign financial institutions, including
Norges Bank, notes and short-term paper and other debt, ie all liabilities other than equity capital,
subordinated loan capital, bond debt and customer deposits.
Higher foreign debt, also in smaller banks
The largest banks generally use foreign money and capital markets as a buffer when they need
extra financing, as can be seen from developments since the mid-1990s. The current credit rating
from international rating agencies ensures favourable terms for banks. Short-term foreign financing
is associated with high liquidity risk. For instance, if a liquidity shortage occurs owing to
turbulence in the Norwegian or international economy, banks may find themselves in a situation
in which they are unable to obtain (re-)financing without incurring considerably higher costs.
In the event of a serious loss of confidence in the Norwegian economy, even the most solid
institutions may encounter problems in rolling over loans when they mature. This is precisely
what happened during the banking crisis in the early 1990s.
Banks' foreign debt has risen sharply since 1995, both in the three largest banks and in smaller
banks6) (see Charts 5.5 and 5.6). In the three largest banks,
short-term financing in the form of deposits from abroad increased considerably up to summer
1997. Since then the largest banks have turned to a greater extent to more long-term financing
in the bond market. During the past year, short-term foreign debt has again increased in importance,
particularly in the form of an increase in new notes and short-term paper. In the first nine months
of 2000, the three largest banks' foreign deposits, loans and notes and short-term paper increased
by NOK 35 billion to roughly NOK 122 billion. This in itself has increased liquidity risk.
In smaller banks, short-term foreign debt has on the whole been increasing since 1995, albeit
from a lower level than in the three largest banks. Foreign bond debt has increased in importance
in recent years, but deposits and loans measured as a percentage of lending have also increased
sharply. Smaller banks' foreign deposits and loans increased markedly towards the end of 1999.
In the first nine months of 2000, short-term debt has risen by a further NOK 8 billion to just
under NOK 36 billion. This has contributed to a marked rise in liquidity risk in smaller banks.
Chart 5.5
Chart 5.6
6) In order to avoid presenting a distorted picture of Norwegian banks'
foreign financing, branches of foreign banks are not included here.
Liquidity risk ahead
In 2000, banks' gross foreign debt has risen by NOK 74 billion to NOK 328 billion at end-September.
Net foreign debt is just over NOK 200 billion. Total foreign debt will probably continue to
increase over the next few years. This is due in part to banks' considerable need for financing
in money and capital markets as long as lending growth is positive and the deposit-to-loan ratio
is under pressure. The latter is due to the strong competition between bank deposits and other
forms of saving such as securities funds and insurance schemes.
Banks are facing increasingly stiff competition from securities markets with regard to the
supply of credit to enterprises. In addition, the Banking Law Commission is discussing the
possibility of allowing banks and mortgage companies to issue asset-backed bonds or to securitise
parts of their loan portfolio. This will probably lead to a somewhat larger portion of capital
intermediation taking place through the securities market rather than through traditional banks,
and contribute to reducing the need for foreign funding somewhat.
Capital movements and their effects on financial institutions
If the sum of the current account surplus and net capital transfers from other countries
to Norway is positive, this will result in a surplus of foreign exchange, which means
increased net foreign financial assets. This may consist of an increase in direct
investment abroad, higher portfolio investments in foreign assets, increased foreign
exchange holdings or repayment of debt. The sum of these investments is Norway's
net foreign lending.
Net lending is defined as saving plus capital transfers less net fixed investment.
Net lending in each sector consists of the accumulation of financial assets in
other domestic sectors plus capital outflows, ie an increase in foreign assets.
Net capital outflows from all sectors are equal to net lending for the country
as a whole.
Throughout most of the 1990s, households had positive net lending. This consisted
primarily of an increase in financial assets in other domestic sectors, in the
form of bank deposits, insurance claims, securities and units in securities funds.
Direct capital outflows comprise just a small portion of household net lending.
Part of households' domestic investments in financial assets is nevertheless invested
abroad through insurance companies and securities funds.
Other participants, such as insurance companies, enterprises and the government,
have in recent years had large capital outflows (see Chart 1). This is partly due
to a desire for diversification. Insurance companies invest part of households'
pension contributions abroad, enterprises invest abroad, and the government
(through the Government Petroleum Fund) invests government budget surpluses
in foreign bonds and equities.
Total capital outflows from these sectors are considerably larger than the
current account surplus. This has meant that other sectors have to have large
capital inflows. At present, banks account for the bulk of such capital inflows.
Banks have recorded a sharp rise in foreign debt since 1995.
In principle, banks do not necessarily need to account for a large proportion of
capital inflows. However, several factors may have contributed to this situation.
Households and enterprises, which account for the bulk of credit demand, could
themselves choose to raise loans abroad. However, lack of expertise in, for
instance, managing currency risk and lack of knowledge of foreign financial
institutions may make this option less advantageous. Moreover, a relatively
small proportion of capital intermediation in Norway takes place through the
securities market (bonds, equities, notes and short-term paper, etc). One of
the reasons for this is that small and medium-sized Norwegian enterprises
seldom have a credit rating from international rating agencies. It is
therefore difficult for foreign operators to assess the credit risk in
Norwegian enterprises. This is why it is more common to turn to Norwegian
financial institutions to satisfy credit demand.
The rise in banks' foreign debt is partly a consequence of the internationalisation
of money and capital markets. It is not just professional investors who wish to
invest in foreign real and financial assets. Households and enterprises have
acquired greater understanding of the value of diversifying the investment of their
savings across different sectors - and across countries. The corollary is that
households and enterprises borrow funds from foreign sources - indirectly through
banks.
Chart 1
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