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 percent and 2.5 percent of banks’ risk-weighted assets, but may be set higher in exceptional circumstances. On the advice of Norges Bank, the Ministry of Finance reduced the countercyclical capital buffer requirement for banks from 2.5 percent to 1.0 percent in March.

Banks should build and hold a countercyclical 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 an economic downturn that causes or potentially causes higher credit losses and clearly reduced access to credit, the buffer should be lowered to increase banks’ lending capacity. 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 even if 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 Q4 is presented in the December 2020 Monetary Policy Report.

The Norwegian economy is in the midst of a deep downturn. Economic activity has picked up since March, but higher infection rates and stricter containment measures are holding back the recovery. On the other hand, there is positive news about vaccines, and there are prospects that vaccination can begin in early 2021. This may result in a faster recovery than previously projected. Nevertheless, it will probably take time for economic activity to return to pre-pandemic levels.

Creditworthy businesses and households appear to have ample access to credit. Banks have the capital and liquidity to maintain credit supply. In Norges Bank’s lending survey, banks reported small changes in credit standards in 2020 Q3. For Q4, banks expect a slight tightening of credit standards for households, reflecting the fact that the expanded flexibility quotas in the regulation on requirements for new residential mortgage loans were not retained after Q3. Issuance volumes in the corporate bond market have been at normal levels, while risk premiums remain slightly higher than levels observed before the turbulence intensified in March.

Prior to the reduction in March, the countercyclical capital buffer requirement was set at 2.5 percent against the background of a build-up of financial imbalances over a long period. Household debt ratios are high and have increased markedly over many years. After rising rapidly over a long period, property prices are at high levels. In recent years, debt growth has slowed and property price inflation has been moderate. During the Covid-19 pandemic, house price inflation has risen markedly, and household credit growth has edged up. These developments should be viewed in the context of lower lending rates and the temporary relaxation of the residential mortgage regulation. Owing to persistently high house price inflation and increased credit growth, financial imbalances may build up further. Commercial property prices fell markedly in the first half of 2020 but rebounded in Q3.

Banks’ profitability increased somewhat between 2020 Q2 and Q3, primarily owing to lower credit losses. The losses fell from 1.0 percent to 0.3 percent of total lending between Q1 and Q3. Total losses in the first three quarters of 2020 were approximately three times higher than the average for the past 20 years, but significantly lower than during the banking crisis. The outlook for losses is highly uncertain. Loan losses will likely be lower in 2021 than in 2020 but will still be markedly higher than the average for the past 20 years.

Banks’ capital ratios increased in Q3 and are well above the capital requirements. Norwegian banks are well equipped to absorb higher losses while maintaining credit supply. Banks’ profitability and capital adequacy suggest that they are able to distribute dividends, although decisions regarding dividends must still take into account the uncertainty surrounding economic developments.

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. On the basis of its current assessment of economic developments and prospects for bank losses and lending capacity, the Committee will advise increasing the buffer in the course of 2021. The Committee expects the buffer to return to 2.5 percent in the period ahead.

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
Sentralbanksjef     Avdelingsdirektør

Copy: Finanstilsynet (Financial Supervisory Authority of Norway)