Financial Stability 2/2000
7 The situation in the financial services industry
Norges Bank: Financial stability 2/2000
7.1 Profit trends and financial strength in banks
7.2 Competitive environment and structural changes
Box: Concentration in the enterprise sector - increased risk for Norwegian banks?
7.1 Profit trends and financial strength in banks
Sound results so far this year
Commercial banks13) have achieved sound results on the
whole in the first three quarters of 2000. Profits before tax were nevertheless somewhat
poorer than in the same period in 1999, measured both in nominal terms and as a percentage
of average total assets (ATA) (see Table 7.1), primarily as a result of lower revenues from
the securities trading portfolio.
Reduced net interest income as a share of ATA also contributes to lower profits. This is
attributable to reduced interest margins as a result of increased competition for deposit
and loan customers (see Section 7.2) and higher financing costs because of a reduced
deposit-to-loan ratio.
The corollary to this is commercial banks' operating expenses, which are lower as a share
of ATA. Measured in nominal terms and in relation to total income
14), the cost level has
risen somewhat. The figures indicate that banks are gradually reaping the benefits of
rationalisation measures implemented over the past few years.
Commercial banks' recorded loan losses have remained at a low, stable level over the
past few years (see Chart 7.1) and now account for 0.1% of gross lending. Commercial
banks also have a low level of non-performing loans and doubtful commitments, reflecting
sound macroeconomic developments.
Savings banks' income and costs are largely in line with developments in
commercial banks. However, the results for savings banks were strongly influenced
by the sale of Fellesdata shares in the second quarter of 2000. This contributed
to a large non-recurring profit for savings banks (see Table 7.2). Even disregarding
this profit, however, savings banks recorded better results than commercial banks.
This is mainly due to higher net interest income as a percentage of ATA because
savings banks have somewhat higher interest margins and a higher share of
equity funding.
Savings banks have, however, developed alternative income sources for deposit and
lending activities to a slightly lesser extent, so that savings banks' other
operating income is lower than that of commercial banks.
Savings banks' losses have been stable in recent years, and amounted to 0.2% of
gross lending in the first three quarters of 2000. As with commercial banks,
loan losses were associated mainly with the enterprise sector.
Chart 7.1
Table 7.1
Table 7.2
13) Norwegian parent banks excluding branches of
foreign-owned banks in Norway, excluding branches of Norwegian banks
abroad, including Postbanken.
14) Excluding price and exchange gains on securities,
foreign exchange and derivatives.
Normalisation of losses and taxes
In considering banks' results so far this year, it should be borne in mind
that losses are very low and that some banks still have losses from previous
years to be carried forward. With a more normal loss level and normal taxation,
the return on equity for some banks would be lower than their own required rate
of return. In the slightly longer term it is likely that banks will have to
increase their underlying earnings, due to an expected normalisation of losses
and taxes.
Sharp growth in lending has reduced capital adequacy
Banks' financial strength (core capital ratio) remained relatively stable in
1998 and 1999. However, figures for the first three quarters of this year indicate
that the capital adequacy of both commercial and savings banks has deteriorated
this past year (see Tables 7.1 and 7.2). This is largely due to the strong growth
in lending.
Chart 7.2 shows developments in core capital ratios and twelve-month lending
growth for the ten largest Norwegian banks as at the third quarter of 1999 and
the third quarter of 2000. Almost all these banks have increased lending growth,
while their core capital ratio has decreased or remained unchanged. Many banks
that were concentrated a year ago in area IV of the chart have now moved towards
the dividing line between areas I and II, where the core capital ratio is about
7% and lending growth higher than 10%.
Chart 7.2
7.2 Competitive environment and structural changes
Various forces contributed to stronger competition and significant structural
changes in the financial sector in the 1990s. In addition to influencing the
situation of the individual institution, these changes may affect the stability
of the financial system.
Major structural changes ...
Mergers and acquisitions have characterised the international financial industry
in recent years. So far, the consolidation trend has been strongest within
individual sectors and national boundaries. Cross-border mergers have mainly
taken place in the Benelux countries and in the Nordic and Baltic regions.
Nordic financial institutions have also been at the forefront with respect to
mergers across sectoral boundaries, for example through banks forming financial
conglomerates with insurance and investment companies. There is reason to suppose
that this trend is partly a response to a change in saving patterns, and partly a
step in a preparatory phase for using cross-border activities to cope with
increased international competition.
... and increased competition ...
Conventional banks increasingly face competition for customer savings
from Internet banks, securities markets and non-financial operators. Internet
banks offer standardised loan products to the retail segment, while banks in
countries with more highly developed securities markets encounter stronger
competition for major loan customers.
Intensified competition has led to a reduction in interest margins, and has
placed banks' earnings from traditional borrowing and lending activities
under greater pressure. This is illustrated in Chart 7.3. The increasing
competition has led to a reduction in the spread in banks' nominal deposit
and lending rates in recent years (see Charts 7.4 and 7.5).
The reduction in the lending margin must be viewed against the backdrop of
the general improvement in the financial strength of borrowers, which has
led to banks reducing the risk premia on loans. There has also been a movement
away from cross-subsidising between different areas of financial institutions'
operations. Both factors contribute to lower lending margins. However, there
is a risk that banks' pricing of loans is not sufficiently geared to the
risk associated with them.
Chart 7.3
Chart 7.4
Chart 7.5
... have led to major challenges for financial institutions
As a result of changes in the competitive and structural situation, the
demands made with respect to cost-effective production and distribution of
financial services are becoming increasingly stringent.
By selling existing products to new customers in new markets, financial
institutions can distribute their costs over a broader customer base.
However, the Norwegian market is probably not large enough to yield sufficient
economies of scale in areas where major investments are required. The same is
probably true of the Nordic market as a whole.
Distinguishing between the development and distribution of products is therefore
an increasingly important strategy for financial institutions. The trend will
probably be towards major financial institutions offering products for distribution
through other banks and financial institutions. Smaller institutions may cooperate,
for instance in the technology area or the production of services, while the
individual institutions still distribute to the retail market. Alliances of this
kind are made in order to realise the benefits of economies of scale and scope,
but are demanding in terms of management, cooperation and coordination.
In the most specialised segments of the major customer market, where production
and distribution are closely interrelated, a number of Norwegian (and Nordic)
institutions will probably be too small to be competitive. Apart from these
segments, the major customers will still be "available" to the largest Norwegian
financial institutions. However, this may change if the largest customers become
even larger (see separate box).
Concentration in the enterprise sector - increased risk for Norwegian banks?
In recent years Norwegian enterprises have grown larger, partly through various kinds of alliances.
This trend is leading to an increase in the size of banks' commitments. In isolation, such
a development could lead to increased risk, since the diversification of banks' lending
portfolios is thereby reduced. The question that is raised here is how well Norwegian banks
are equipped to deal with an increased concentration in the enterprise sector.
Developments in the concentration of enterprises and banks can be measured in various ways.
In Chart 1, we have chosen to show the concentration in the enterprise sector's long-term
debt1) in Norway over the past four years. We have
chosen to look only at enterprises that existed during the whole period from 1995 to 1999.
Whereas the debt of the 15 largest enterprises accounted for 23% of total enterprise debt
in 1995, this share had increased to 33% in 1999. The share of debt accounted for by the
1000 largest enterprises had increased from 64% to 79%.
Chart 2 illustrates the percentage change in debt (adjusted for price inflation during the
period) for all enterprises, showing that the debt of the largest enterprises has grown most.
For example, in 1999 the debt of the 15 largest enterprises was 81% higher than that of the
15 largest enterprises in 1995, while the debt of all enterprises in our selection increased
by only 26%. The number of enterprises with interest-bearing debt of more than NOK
100m2)2) increased from 656 in 1995 to 837 in 1999,
an increase of 28%.
An important question is whether banks have adapted to the increased concentration in the
enterprise sector. Growth in the equity capital of the ten largest Norwegian banks in 1999
that also existed in 1995 is shown in Chart 2. The equity capital of the three largest
banks increased by 77% during this period. This is due partly to DnB's acquisition of
Postbanken, and Union Bank of Norway's acquisition of Gjensidige Bank. Growth in equity
capital has been somewhat weaker for the seven next largest banks, but has nonetheless
increased by 54% during the past four years. The growth in equity capital in the largest
Norwegian banks indicates that these banks have to a very large extent accumulated
capital corresponding to the increased concentration in the enterprise sector
(see Chart 2).
Chart 1
Chart 2
1) This is an approach in relation to the size of loans granted
by Norwegian banks. Debt may also include bond debt and loans from foreign sources.
2) To obtain as true a comparison as possible, in 1999 the number
of enterprises with debt of more than NOK 108.6 million was measured, which corresponds
to NOK 100 million in 1995.
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