Financial stability implies that the financial system can efficiently perform its societal role even when subjected to considerable shocks. Shocks to a small open economy like Norway will often originate in other countries. Vulnerabilities can cause or amplify financial stress and economic downturns when the economy is exposed to shocks.

Financial system vulnerabilities can be time-varying or the result of more permanent structural conditions. Vulnerabilities may, for example, be a high debt level, high property prices and unstable bank funding.

The purpose of macroprudential supervision is to mitigate the build-up of vulnerabilities in the financial system or increase resilience to shocks. There are different instruments used in macroprudential supervision. Capital buffer requirements make banks more resilient. The objective of the lending regulation is to dampen borrowing and reduce household vulnerabilities. Requirements in the regulation include a capital requirement for residential mortgage loans, which sets a limit for the amount a household may borrow.

The financial system must be able to absorb large shocks

Banks must be able to lend money to private individuals and businesses, invest savings and redistribute risk in both upturns and downturns. In addition, payments for goods and services must function as normal.

Downturns can be amplified if banks and other financial market participants are unable to perform their tasks. It is therefore important that they are resilient to losses and financial stress. To ensure this, banks must meet strict regulatory requirements during upturns.

Statutory banking requirements

The countercyclical capital buffer is a macroprudential instrument that contributes to building bank capital during upturns. During downturns, the buffer rate can be reduced. This can prevent banks from amplifying a downturn by over-tightening their lending to comply with capital requirements.

Banks face a number of other capital requirements, including the systemic risk buffer. The current level of the buffer reflects structural vulnerabilities in the Norwegian economy. Banks’ substantial exposure to commercial real estate is an example of such a vulnerability. If problems at an individual bank can have substantial negative consequences for the financial system and the real economy, the bank is considered systemically important and will be subject to additional capital requirements (buffer for systemically important financial institutions).

Liquidity requirements and stable funding requirements are also among the instruments employed to reduce banking system vulnerability.