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 Q3 is presented in the September 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 led to a sharp fall in activity in the Norwegian economy. A lower buffer rate reduced the risk of tighter lending standards, which could have amplified the downturn.

Economic activity has picked up in recent months but remains lower than at the beginning of the year. Financial market turbulence has subsided further and risk premiums on bank funding have returned to almost the same levels prevailing before March.

Growth in corporate credit has fallen markedly since September 2019, reflecting lower business investment. Household credit growth has gradually slowed over the past three years, but has recently levelled off. In Norges Bank’s lending survey for 2020 Q2, banks reported high residential mortgage demand, while corporate demand declined somewhat. Banks reported minor changes in credit standards in Q2 and did not expect to make any changes in Q3. Corporate bond issuance has picked up in recent months and risk premiums have declined somewhat. Overall, this suggests that households and businesses have ample access to credit.

House price inflation has been moderate in recent years. However, since May, the rise in house prices has picked up and turnover has been high compared with previous years. This development may be due to very low mortgage lending rates and the temporary relaxation of the regulation on requirements for new residential mortgage loans. Residential construction has slowed in recent years, while household formation has remained steady. Together with low interest rates, this may drive up prices ahead, particularly in urban areas. Owing to persistently high house price inflation and rising household credit growth, financial imbalances may build up further.

The office segment of the commercial real estate (CRE) sector is especially important for financial stability since banks’ exposure to this segment is substantial. A relatively large share of the stock of office buildings is located in Oslo. Selling prices for prime real estate in Oslo are high after having risen sharply over several years. In the first half of 2020, prices fell, driven in particular by lower rents. A sharp decline in selling prices is not expected ahead.

Banks’ profitability increased in the period between 2020 Q1 and Q2, primarily owing to lower credit losses. However, credit losses in Q2 were appreciably higher than the average for the past 20 years, primarily reflecting losses on oil-related exposures. There is still uncertainty related to credit losses ahead. In the near term, the risk of losses is particularly associated with developments in oil-related industries. In the longer term, CRE developments will be particularly important. CRE companies have relatively high equity ratios, and losses on banks’ CRE exposures are expected to be limited in the years ahead. Norwegian banks are well equipped to absorb higher losses while maintaining credit supply. Banks’ capital ratios increased in Q2 and are well above the capital requirements.

Norges Bank’s Monetary Policy and Financial Stability Committee has unanimously decided to advise the Ministry of Finance to keep the buffer rate unchanged at 1.0 percent. The Committee does not expect to advise the Ministry to increase the buffer rate again until 2021 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