Financial Stability 1/2000
2 Introduction
Norges Bank: Financial stability 1/2000
One of Norges Bank's main responsibilities is to foster robust and efficient payment systems
and financial markets. The preventive tasks in this area are:
- To contribute
to limiting risk in clearing and settlement systems
- To monitor the
financial industry in order to identify trends which may weaken stability
in the financial sector and lead to systemic problems
- To assess the
influence of monetary policy and general economic policy on stability
in the financial sector and vice versa.
Monitoring financial stability
The report on financial stability is a key element in monitoring the financial
industry. The report includes an assessment of the effects that any major
disturbances may have on the financial sector, ie the consequences of
possible disturbances in the economy or changes in market participants'
expectations. To a certain extent, it also contains an assessment of the
probability of disturbances or marked changes in expectations. The combination
of the likelihood of disturbances and possible consequences gives some
indication of total risk exposure in the financial sector.
The consequences of substantial disturbances in the economy depend on
several factors:
- Banks' exposure
to different types of risk
- Developments in
underlying conditions which influence the different types of risk, such
as the debt burden of households and enterprises
- Banks' earnings
and financial strength, ie how well equipped banks are to deal with
any losses
- The extent to
which mechanisms exist which ensure that problems arising in one part
of the system are not ampli- fied and/or do not spread to other parts
of the system
The likelihood of major disturbances or negative impulses
as a result of changes in expectations is assessed in part by monitoring
macroeconomic developments, changes in the national and international
finance markets, and competition trends in the financial industry.
Risk in the financial sector
The financial sector is exposed to different kinds of risk. In
this report, we have chosen to focus on the following four main
types:
Market risk: the risk of losses as a result
of changes in interest rates, exchange rates or share prices.
Settlement risk: the risk of losses and
liquidity problems in connection with clearing and settlement functions.
Includes credit risk, liquidity risk and operational risk. Transactions
in the payment system are generated by customers, and the subsequent
exposures are not the result of explicit credit assessments. This
means that risk in the settlement system is a special type of risk.
Liquidity risk: the risk that a financial
institution is not able to meet its obligations when they are due
without generating considerable extra costs in the form of higher
charges for refinancing or substantial reductions in the price of
assets which have to be realised. The risk is primarily ascribable
to the fact that financial institutions, particularly banks, largely
finance a relatively long-term lending portfolio through short-term
deposits and borrowing.
Credit risk: the risk of losses on loans,
primarily to households and enterprises. Financial institutions'
attitude to collateral and general practice as regards the size
of loans in relation to the value of collateral are also important
in this context.
Financial stability and risk
The report focuses on the different types of risk to which financial institutions
are exposed through their operations (see separate box). As banks play
a pivotal role in the payment system and deposit and loan market, and
because Norges Bank has a special function in relation to banks, the report
places particular emphasis on banks and their risk exposure. In order
to provide a qualitative assessment of risk, changes in factors which
are significant to the different types of risk and banks' exposure to
each type of risk are presented in the four sections on market risk, settlement
risk, liquidity risk and credit risk.
In addition to analyses of the different types of risk,
the report includes an assessment of competition in the financial industry
and the effects of changes in competition on underlying earnings and financial
strength. This takes the form of various scenarios for banks' profits
and balance sheets in the next three-year period, based on assumptions
regarding trends as a result of the analyses in the other sections.
Financial stability and macroeconomic developments
Several of the conditions examined in connection with financial institutions'
risk exposure will be affected by cyclical changes. Projections for future
developments in the real economy are therefore of considerable importance
to any assessment of stability in the financial system. In this report,
assumptions regarding macroeconomic changes in the period ahead are based
on projections in Norges Bank's March 2000 Inflation Report.
The most important change in relation to the last Inflation
Report is an upward adjustment of projections for total demand and production
this year and next. Household real income growth is expected to be somewhat
slower this year than in 1999, and income growth is expected to pick up in the
years ahead as a result of higher employment growth and rising wage inflation.
Increased borrowing in line with expectations of higher house prices will contribute
to a rise in interest expenses, and will curb growth in disposable income. Growth
in total private consumption has been adjusted upwards to 2¾% this year,
2½% in 2001 and 2¾% in 2002. The saving ratio is expected to be
around 6% in the years ahead.
Higher export prices and improved productivity are expected
to contribute to improved profitability in manufacturing industry, with
an increase in manufacturing investment as a result. Higher growth in
private consumption will also lead to increased investment in the services
industry and distributive trades over the next few years. The increase
in investment will probably mean that new loans raised by enterprises
will fall less than previously expected, and that debt growth may rise
somewhat from next year. Growth in mainland GDP is projected at 1½%
this year, 2% next year and 2¼% in 2002.
Overall, the macroeconomic picture indicates that the
risk of an economic downturn in the next couple of years is limited. Consequently,
the likelihood of substantial disturbances or negative impulses as a result
of a change in expectations has been reduced.
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