Norges Bank is responsible for preparing a decision basis and advising the Ministry of Finance on the level of the countercyclical capital buffer for banks four times a year. The buffer rate is set at 1.5 percent effective from 30 June 2016. The decision basis for Norges Bank's advice on the countercyclical capital buffer in 2016 Q3 is presented in the September 2016 Monetary Policy Report (3/16).

The premise for Norges Bank's assessment is that banks should build up and hold a countercyclical capital buffer when financial imbalances are building up or have built up. The buffer rate will be assessed in the light of other requirements applying to banks. The buffer rate can be reduced in the event of an economic downturn and large bank losses with a view to mitigating the procyclical effects of tighter bank lending. The buffer rate should not be reduced automatically even if there are signs that financial imbalances are receding. Advice to reduce the rate will be based on factors such as information about market turbulence, significant credit supply tightening and prospects for substantial bank losses. The countercyclical capital buffer is not an instrument for fine-tuning the economy.

Norwegian banks have built equity capital in recent years in order to meet higher Common Equity Tier 1 (CET1) requirements, including the countercyclical capital buffer. Capital levels continued to rise in 2016 Q2. The largest banks meet the requirements applicable from summer 2016 by an ample margin, but must continue to build capital to reach their announced capital targets. Banks' loan losses have increased in recent quarters, particularly from oil-related exposures. Banks’ loan losses will probably continue to edge up in the quarters ahead, but are nonetheless expected to remain at relatively low levels.

Norges Bank's assessment of financial imbalances is based on the credit-to-GDP ratio and its deviation from a long-term trend. Total credit to households and enterprises has expanded faster than mainland GDP for a long period. Although overall credit growth has gradually slowed over the past year, the credit-to-GDP ratio has nonetheless risen owing to lower growth in the Norwegian economy.

Although household credit growth has slowed somewhat over the past year, household debt is still rising faster than disposable income. Since the Ministry of Finance introduced the regulation on requirements for residential mortgage loans in 2015, the percentage of new loans with particularly high loan-to-value ratios has edged down. Norges Bank notes that the Ministry has circulated for comment a proposal to tighten the current regulation on requirements for new residential mortgage loans.

Mainland corporate credit growth is still moderate and is being held up by bank lending. Banks in Norges Bank’s lending survey reported weaker corporate credit demand in Q2. Credit standards have remained approximately unchanged in recent quarters. In recent months, risk premiums on bonds have decreased for enterprises with a high credit rating, but have remained elevated for oil service enterprises.

The European Systemic Risk Board (ESRB) recommends the calculation of technical reference rates for the countercyclical capital buffer (a buffer guide). The reference rates will reflect the level of the credit indicator measured as the deviation from its estimated long-term trend. Applying the trend estimation method proposed by the Basel Committee, the reference rate was 0 percent in 2016 Q2. Using an alternative trend estimation method, which has been shown to provide a better leading indicator of crises, the reference rate was ¾ percent in 2016 Q2. The ESRB emphasises that there should not be a mechanical relationship between the reference rate and the buffer rate, but that the buffer rate should be based on a broader decision basis.

In addition to the credit indicator, Norges Bank takes account of developments in real estate prices and banks' wholesale funding ratios. House prices are rising at a considerably faster pace than household disposable income. Over the past half year, house prices have risen sharply in Oslo and the surrounding areas, and house price inflation has also picked up in other parts of the country. In oil-dependent regions, house price inflation is still weak. Commercial property prices, measured in terms of real prices for centrally located office space in Oslo, continued to rise in the first half of the year. Banks’ wholesale funding ratios are stable, and Norwegian banks have ample access to wholesale funding. Risk premiums on bank bonds have continued to fall.

The persistent rise in household debt ratios and high property price inflation in recent years are signs that financial imbalances have built up. Over the past year, corporate credit growth has been moderate and household credit growth has edged down. House prices have risen sharply recently. High house price inflation may lead to higher growth in household borrowing, increasing household sector vulnerabilities, with a higher risk of an abrupt decline in demand and bank loan losses further ahead. In isolation, this suggests that the countercyclical capital buffer could be raised. On the other hand, continued weak growth in the Norwegian economy may dampen credit growth in both the household and corporate sector. In addition, there has been some increase in banks’ loan losses. In such a situation, a higher countercyclical capital buffer will increase the risk of banks tightening their supply of credit to the corporate sector.

On the basis of an overall assessment, Norges Bank's Executive Board has decided to advise the Ministry of Finance to keep the buffer rate unchanged.

In preparing its advice on the countercyclical capital buffer, Norges Bank has exchanged information and assessments with Finanstilsynet (Financial Supervisory Authority of Norway).

Sincerely,

Øystein Olsen

Torbjørn Hægeland

Copy: Finanstilsynet