Financial Stability 1/2000
1 Summary
Norges Bank: Financial stability 1/2000
Risk of further corrections in stock markets
As pointed out in the last report, the main international risk to stability
in the financial system is the risk of substantial corrections in stock
markets. Over the past six months, international stock markets have been
influenced by the sharp rise in prices for technology shares, whereas
traditional share prices have stagnated and in some countries have declined.
Stock markets have been edgy since mid-March, and characterised by substantial
price fluctuations. In addition, prices for technology shares have fallen
considerably. Share price performance in the Norwegian securities market
has largely shadowed international developments. Life insurance companies
in particular are vulnerable to any sharp fall in share prices, whereas
the direct effect of a change will be comparatively small for Norwegian
banks with limited securities holdings.
Chart 1.1
Lower risk in the payment system
The positions that arise between banks as a result of substantial transactions
in the payment system can be a source of instability in the financial
system. The potential has diminished considerably since the introduction
of Norges Bank's settlement system (NBO), which commenced in 1997. Transactions
that are settled individually and continuously in NBO accounted for nearly
80% of turnover in 1999, compared with 30% in 1998. As a consequence,
there was a marked decline in the number of settlements where several
transactions are cleared and settled in batches after a period of time.
Increase in domestic credit growth
Growth in credit from domestic sources has increased in the past six months.
The distribution by borrowing sector shows that credit growth has risen
in the household sector and decreased in the enterprise sector. However,
growth in credit from foreign sources has fallen considerably, resulting
in a decline in total credit growth. It would therefore seem that the
risk of imbalances developing in the financial system as a result of strong
credit growth has been reduced.
Chart 1.2
Credit risk linked to the enterprise sector remains high,...
Enterprise sector debt burden is now at the same level recorded at the end
of the 1980s, and is expected to edge up in the years ahead. In 1999, there
was strongest growth in banks' loans to industries exposed to risk, such as
the property management and shipping/pipeline transport industries, which already
had a high level of debt at the start of the year. The high debt burden means
that enterprises are more vulnerable to major economic shocks. On the other
hand, the Norwegian economy is expected to follow a more favourable trend than
previously, which reduces the likelihood of serious financial problems in a
large number of enterprises. Overall, credit risk in parts of the enterprise
sector is still considered to be high in relative terms.
Chart 1.3
...but little risk of losses on loans to the household sector
Households' gross loan debt has increased in recent years, but only at
a slightly faster pace than income. The increase in debt is matched by
an even greater increase in housing wealth. Households' debt burden is
expected to continue to rise in the period ahead, in part due to expectations
of a continued rise in prices for existing homes and higher housing investment,
which normally lead to increased borrowing. Despite the increase in the
debt burden, the credit risk associated with the household sector is considered
to be moderate.
The financing gap in banks is expected to widen
There are many indications that banks' deposit-to-loan ratio will continue
to decline in the period ahead. As a result, the need for financing from
other sources is increasing. A considerable part of the financing gap
is expected to be covered by foreign loans. Developments in liquidity
risk in the period ahead will largely depend on the maturity chosen by
banks for this form of financing. In this report, it is argued that liquidity
risk increases in line with a growing share of short-term foreign financing.
Expected developments in the Norwegian economy and banks' earnings and
financial strength indicate that liquidity risk is likely to be limited
in the period ahead.
Chart 1.4
Banks achieved good results in 1999,...
Financial institutions, with the exception of finance companies, recorded a
marked improvement in operating profits in 1999, primarily due to an increase
in other operating income as a result of favourable developments in the securities
market. In addition, banks reduced costs as a share of total assets. Commercial
banks also reduced nominal costs. Losses continue to be low. Even though some
of the improvement may be explained by extraordinary conditions, underlying
earnings have also been good in the past year. In 1999, commercial banks recorded
a rise in the core capital ratio, whereas savings banks recorded a small decline.
Both bank groups satisfy the minimum core capital requirement by a good margin.
Chart 1.5
...but still face challenges in the period ahead
Increased competition is expected to result in continued pressure on interest
margins and market shares for deposits and loans, and thereby the need
to focus on increasing other operating income. Competition is also expected
to intensify in these areas. In addition, anticipated higher loan losses
imply a continued need to focus on cost levels in the period ahead. It
is not likely that banks will be able to adjust the total cost level without
a substantial reduction in costs associated with traditional distribution.
New technology, and in particular the increased focus
on using the benefits of the Internet, will require considerable investments.
Such investments will also change cost structures, with an increase in
fixed costs. This will amplify the need to achieve sufficient volumes,
which in turn will lead to keener competition.
Projections indicate that banks' earnings and return
on equity will deteriorate somewhat compared with 1999. Even though earnings
do not fully satisfy banks' own equity return requirements, earnings are
considered to be sufficient to maintain capital adequacy at satisfactory
levels, on the assumption that lending growth will be moderate in the
period ahead.
Chart 1.6
Financial stability remains satisfactory
In the short term, the total risk in the banking sector is considered
to be relatively limited. However, higher losses on loans to the enterprise
sector are expected in the longer term. Overall, stability in the financial
system still appears to be satisfactory.
Even though the real interest rate after tax is now
higher than the low levels recorded in 1996-1997, it is still considerably
lower than in the first half of the 1990s. A somewhat higher real interest
rate will increase the interest burden in the short term, but will curb
debt growth in the longer term. This may help to prevent the build-up
of financial imbalances in the economy.
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