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 countercyclical capital buffer shall as a rule be set at between 0 and 2.5 percent of banks’ risk-weighted assets, but may be set higher in exceptional circumstances.

Banks should build and hold a countercyclical capital buffer when financial imbalances are building up or have built up. Large financial imbalances entail a risk of an abrupt decline in demand from households and businesses and large bank losses. In the event of a severe downturn and clearly reduced access to credit, the buffer rate should be lowered to counteract tighter bank lending. The buffer rate should not be changed frequently in an attempt to manage credit growth or asset prices. Nor should the buffer rate be reduced automatically when there are signs that financial imbalances are receding. Norges Bank’s framework for advice on the countercyclical capital buffer is described in Norges Bank Papers 4/2019. The decision basis for Norges Bank’s advice in 2020 Q2 is presented in the June 2020 Monetary Policy Report.

On the advice of Norges Bank, the Ministry of Finance reduced the countercyclical capital buffer rate from 2.5 percent to 1.0 percent in March. This was related to the outbreak of Covid-19 and the measures to contain it, which have led to a sharp fall in activity in the Norwegian economy. A lower buffer rate reduces the risk of tighter lending standards, which could amplify the downturn.

Developments since the buffer rate was lowered in mid-March confirm that the Norwegian economy is in a severe downturn. Extensive measures introduced by the authorities have dampened the downturn. At the same time, financial market volatility has diminished and risk premiums on banks’ wholesale funding have fallen.

Growth in corporate credit has fallen markedly over the past six months, while growth in credit to households has been gradually slowing for three years. In April, growth edged down further for both households and businesses. Government measures are supporting both the supply of and demand for credit. In Norges Bank’s lending survey for 2020 Q1, banks announced that they would tighten their credit standards somewhat in 2020 Q2. Corporate bond issuance was low in March, but picked up in April and May. Overall, this suggests that households and businesses have ample access to credit.

In the housing market, both turnover and prices fell sharply in March but rebounded fairly quickly. House prices rose substantially in May and offset most of the fall. Housing market developments do not therefore indicate a fall in prices ahead that will result in a further tightening of household consumption and higher bank losses.

High commercial property prices are one of the key financial system vulnerabilities. In the commercial real estate (CRE) sector, the impact of the downturn has been particularly severe for owners of retail property and hotels. The office segment is especially important for financial stability since banks have substantial exposures to this segment. A relatively large share of the stock of office buildings is located in Oslo. Selling prices for prime real estate in Oslo fell markedly in 2020 Q1, reflecting both lower rents and higher yields. CRE companies' equity ratios are relatively high and preliminary analyses indicate that banks will not face substantial losses on CRE exposures in the coming year.

Increased credit losses have reduced banks’ profitability. Banks’ earnings in 2020 Q1 showed annualised losses corresponding to approximately 1 percent of lending. Norwegian banks are solid and can absorb losses. Norges Bank’s estimations indicate that the reduction of the countercyclical capital buffer rate has contributed to the ability of banks to absorb losses of more than 2 percent of lending in 2020 while also maintaining credit supply, even in the event of a sharp fall in income. Banks’ credit losses in 2020 are expected to be below this level, but the evolution of losses is highly uncertain. A weaker economic outlook may result in higher credit losses than expected. In the near term, the risk of losses is primarily associated with developments in oil-related industries. In the longer term, CRE market developments will be particularly important.

Should higher bank losses lead to clearly reduced access to credit, a further reduction in the countercyclical capital buffer rate may be appropriate. Banks should implement measures to ensure that they can maintain credit supply. This should be taken into consideration in decisions on dividend payouts ahead.

Should property price inflation and credit growth accelerate further ahead, owing in part to persistently low interest rates, financial imbalances may build up. Increasing the countercyclical capital buffer may then be appropriate.

Norges Bank’s Monetary Policy and Financial Stability Committee has decided to advise the Ministry of Finance to keep the buffer rate unchanged at 1.0 percent. The decision was unanimous. The Committee does not expect to advise the Ministry to increase the buffer rate again until 2021 Q1 at the earliest. Normally, implementation of an increase in the countercyclical capital buffer will not then be required until 2022 Q1 at the earliest.

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

Sincerely,

Øystein Olsen 

Torbjørn Hægeland

Copy: Finanstilsynet