Improved Financial Stability...

... but Norges Bank will increase capital requirements for Norwegian Banks.

(20.05.2011) ... but Norges Bank will increase capital requirements for Norwegian Banks.

By Kyrre Aamdal, Senior Economist at DNB Markets

The U.S. key figures were on the weak side yesterday. Philly fed fell from 18.5 to 3.9, versus an expected rise. The index has now fallen below its long term average, weighted down by shipments and orders. Together with a decline also for Empire State a few days ago, the Philly Fed index indicates a decline also for the ISM index.

Also, the existing home sales fell from March to April, and the number of unsold homes increased further. The high level of unsold homes indicates further declines in existing home prices. Leading indicator showed a small decline, versus an expected increase. The most positive data was that the level of initial claims fell to 409 – a level seen before Easter.

The dollar did not react much on the figures, but has fallen 0.2 per against the Euro since yesterday morning. In UK the retail sales increased substantially in April, partly due to good weather and the royal wedding. This might have contributed to a 0.2 per cent increase for the Sterling versus the Euro. The Norwegian krone has continued with a slowly strengthening and EURNOK trades this morning around 7.86.

Yesterday Norges Bank released its first Financial Stability report for this year. Norges Bank states that: "The financial system is somewhat less vulnerable than at the time of publication of the November 2010 report. Domestic macroeconomic conditions have improved, resulting in lower loan losses and solid earnings for banks". A substantial part of the report was devoted to the banking sector. Norges Bank says the banks have used their solid earnings to strengthen equity capital. There are no signs of tight credit conditions. Almost all the banks satisfy the announced Basel III capital requirements, but capital adequacy is still lowest in the large banks. Most banks also have sufficient capital to satisfy a countercyclical buffer requirement.

Norges Bank has shown attention to three major fields. First, The Executive Board recommends that the new requirements from the Basel Committee (Basel III) to be incorporated into Norwegian law as quickly as practically possible. The transition period should be shorter than recommended by the Basel Committee. Since the large Nordic banks are active in several countries, the Nordic authorities should cooperate on phasing in the new requirements.

, Norges Bank highlights that in an international context risk weights for residential mortgage loans in the large Nordic banks have been very low. As a result, they need little equity capital to provide such loans. The risk weights are based upon long-term loss history for mortgages, but Norges Bank is concerned that systemic risks are not adequately represented in the risk weights. Norges Bank recommends that efforts should be made, in cooperation with the authorities in other Nordic countries, to enable the introduction of a lower limit on banks’ risk weights for residential mortgage loans.

, Norges Bank points to a high and rising debt burden that makes households vulnerable to a loss of income or a marked rise in interest rates. This represents a future risk in the financial system and calls for a gradual increase in the policy interest rates. At the press conference vice governor Qvigstad said Norges Bank would no be worried if existing home prices and households' credit increase with annual 5 to 10 per cent growth rates. But if the growth rates go up to 15-20 per cent, Norges Bank would be uncomfortable.

Today Norges Bank's governor Øystein Olsen will meet at a hearing before the Standing Committee on Finance and Economic Affairs of the Storting (Norwegian parliament). This is an annual occurrence in connection to the Parliaments discussion of an annual governmental report on financial markets. Olsen's introductory statement will be released on Norges Bank's website.