Financial Stability 1/2000

Print

5 Liquidity risk

Norges Bank: Financial stability 1/2000

Reduction in bank deposits increase need for other bank financing

In recent years, lending growth has generally been higher than growth in customer deposits, with an increased need for funding from other sources. Developments in liquidity risk depend on how this funding need is covered.
   Customer deposits can often be withdrawn at short notice, but are still considered to be a stable short-term funding source. In the longer term, bank deposits will be met with strong competition from other investment alternatives such as securities funds and insurance schemes. In addition, customer deposits are considered to be less costly than other forms of funding. These factors explain why banks seek to maintain a high deposit-to-loan ratio. However, it may be more costly to increase the share of deposits than to finance increased lending in other ways. If banks increase deposit rates to attract customer deposits, they would have to offer existing customers similar terms, which may lead to a considerable increase in the costs associated with customer deposits.
   The larger banks consider the Norwegian capital market as less liquid than foreign markets and they therefore frequently turn to foreign markets for funding. This has implications for liquidity risk, as short-term foreign funding in particular is associated with volatility. One reason for this is that foreign operators are less familiar with the Norwegian economy than domestic participants, and may thus be prone to herd behaviour. According to a report of the Basel Committee⁴ foreign operators are less apt than domestic operators to distinguish between rumours and facts in the short run.

⁴Basel Committee on Banking Supervision: "Sound Practices for Managing Liquidity in Banking Organisations", Basel February 2000.

Marked increase in savings banks' short-term debt

One way of assessing developments in liquidity risk is to look at changes in liquid assets and short-term debt. We do not have information about drawing rights or similar bank agreements designed to steer liquidity. Our analysis is thus based on banks' balance sheets.
   Chart 5.1 shows that savings banks have reduced their liquid assets throughout the 1990s as a result of a reduction in securities holdings. From 1995, savings banks increased their funding from other financial institutions and in the certificate market (see Chart 5.2). Measured as a percentage of total assets, the difference between short-term debt and liquid assets is now substantially greater than in 1995, when these two were virtually the same. This alone implies increased liquidity risk..
   Chart 5.3 shows that commercial banks' liquid assets measured as a percentage of total assets ranged between 15% and 20% in the 1990s. Like savings banks, commercial banks have markedly increased their short-term funding since 1995, but this trend was reversed in the summer of 1997 (see Chart 5.4). This has contributed to reducing the difference between short-term debt and liquid assets, and this difference is now narrower than for savings banks.

Chart 5.1      Chart 5.2      Chart 5.3      Chart 5.4 

Foreign funding increases liquidity risk

Since1995 there has been a shift towards increased foreign funding as banks have financed the widening difference between customer deposits and loans in foreign markets. Charts 5.5 and 5.6 show that short-term loans account for a large share of foreign funding, which has led to an increase in liquidity risk. An increase in long-term financing in the bond market as from 1997 has countered the increase in liquidity risk to some extent. The growth in banks' foreign debt came to a halt in 1998 while lending growth slowed somewhat and customer deposits increased. For commercial banks, foreign debt has recently been stable. Savings banks have increased their short-term funding in the form of deposits from foreign financial institutions in the course of 1999. A contributory factor was a lower deposit-to-loan ratio as a result of high lending growth.
   Savings banks' short-term foreign funding is now higher than the peak level recorded in 1987-1988. Some savings banks' short-term foreign debt as a percentage of loans is on a par with or higher than that of commercial banks.

Chart 5.5      Chart 5.6

Liquidity risk ahead depends on banks' choice of funding sources

In the years ahead competition from forms of saving other than bank deposits is expected to intensify, and with lending growth expected to remain high, the deposit-to-loan ratio is expected to fall (see Section 7). Developments in liquidity risk will depend on whether banks cover this using long-term sources rather than short-term deposits from foreign banks.
   The choice between short-term and long-term funding will to a large extent be determined by banks' assessment of liquidity risk and the cost of short-term versus long-term funding, which will depend on the rating assigned to banks by the international rating agencies. Banks' profitability and capital adequacy will be important in this context.

© 2000 Norges Bank webmaster@norges-bank.no