## EXECUTIVE SUMMARY

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---

### Background and Context
- Norway is a major oil exporter with significant financial buffers: about US$1 trillion in assets, or about 260 percent of GDP.
- Public finances and social safety nets were strong at the onset of the COVID-19 pandemic.
- Long-term structural headwinds: population aging, slow productivity growth, and an anticipated decline in oil production.
- Much of the 2020 FSAP work was conducted prior to the COVID-19 outbreak; findings and recommendations remain pertinent and the risk assessment quantifies the impact of the COVID-19 crisis on bank solvency.

### Macrofinancial Developments
- Policy and economic moves:
  - Following the 2014 oil-price drop, growth recovered during 2016–18 supported by rebounding oil prices, accommodative policies, and krone depreciation.
  - Norges Bank raised its key policy rate four times between September 2018 and September 2019 to 1.5 percent, then cut rates to zero percent in March–May 2020 in three steps.
  - The global COVID-19 shock from late February 2020 caused a sharp decline in economic activity, a spike in unemployment, and substantial further depreciation of the krone.
- Real estate and debt:
  - Residential real estate (RRE) prices increased by 70 percent over the last decade; in Oslo they doubled.
  - Household debt levels now exceed 200 percent of disposable income on average.
  - Share of households with debt exceeding five times gross income has been rising.
  - Commercial real estate (CRE), especially Oslo’s prime office market, has also boomed.
  - Corporate debt levels are about average in international peer comparison.

### Financial System Structure and Developments
- Post-2015 reforms:
  - Regulatory capital requirements for banks were raised.
  - Actions taken to bolster insurers’ weak capital position.
  - Temporary borrower-based measures for residential mortgages were introduced and appear to have had some moderating impact.
  - Resolution framework strengthened with implementation of the Bank Recovery and Resolution Directive (BRRD) and designation of Finanstilsynet (FSA) as resolution authority.
- Remaining vulnerabilities:
  - High bank exposure to real estate risks amid elevated RRE valuations and high household debt.
  - Banks’ reliance on international wholesale funding markets.
  - Emerging risks from a tight CRE market.
  - Some key weaknesses identified in the 2015 FSAP remain only partly addressed.

### Systemic Risk Analysis and Stress Testing — Scope, Scenarios, and Key Results
- Top-down solvency exercise:
  - Horizon: 3 years; sample: 11 largest domestic banks (~80 percent of domestic banking assets; ~60 percent of total banking system assets for top-down sample).
  - Hurdle rates average about 10 percent CET1 ratio (includes all capital requirements and buffers after adoption of the European capital framework but excluding the CCB and CCyB).
- COVID-19 solvency stress tests:
  - COVID central scenario: Norwegian mainland GDP contracts by almost 5½ percent in 2020; economy rebounds from H2 2020.
  - COVID downside scenario: GDP decline of about 7 percent in 2020 with a more gradual recovery.
  - Results: aggregate CET1 ratio for in-sample banks drops by about 4 percent under the central scenario and 4½ percent under the downside scenario. Under the COVID downside scenario, one bank would exhaust its buffers in excess of the hurdle rate, though without breaching it.
- Market shock solvency stress test:
  - Assumptions: multi-year recession with fall in level of GDP of over 5 percent by the second year (an almost 3 standard-deviation shock); RRE prices decline by 35 percent; CRE prices decline by more than 50 percent; equity prices fall by 40 percent over first two years; oil price drops to US$27 per barrel; no policy response assumed.
  - Outcome: materially larger impact on banks’ capital in years two and three; FSAP top-down average CET1 drop about 5 percentage points; Norges Bank estimate on the order of 6.2 percentage points.
  - FSAP top-down test results: buffers in excess of hurdle rates would be depleted only partially for most banks and fully for three of them; no material breaches of hurdle rates in FSAP and FSA exercises.
  - Bottom-up tests (three largest banks) project more contained declines than top-down exercises.
- Liquidity stress tests:
  - LCR (1-month horizon): average LCR for 11 banks remains above 100 percent across individual scenarios, though some banks breach threshold under severe combinations; LCR in EUR and USD remains well above 100 percent in all cases.
  - Cash flow analysis (up to one year): under mildly adverse scenario, banks can handle net outflows; under severely adverse scenario, starting from 3–4 months bucket the whole system would experience counterbalancing capacity gaps; debt issuance and rollover risks are critical.
- Interconnectedness and contagion:
  - Nordic-region market-valuation spillover analysis shows important but time-varying interconnectedness; some weakening of links since 2017.
  - Norges Bank assessment: direct and indirect contagion effects could amplify capital depletion under stress by 1 percent on average and up to 2.5 percent in the worst case considered.

### Climate-Related Transition Risk
- Transition risks (policy and technology changes) are more material for Norway than physical climate risks given Norway’s role as a major oil and gas producer.
- Two partial-equilibrium analyses:
  - Carbon price simulations to US$75 and US$150: firms in emission-intensive sectors (e.g., waste management and transportation) would be materially impacted; banks’ increase in debt-at-risk remains small on average but significant for banks concentrated in exposed sectors.
  - Permanent fall in global oil demand via higher global carbon taxes:
    - Carbon price of US$75: estimated increase in loan loss rates by about 0.3 percentage points (a doubling from pre-COVID levels).
    - Carbon price of US$150: estimated increase in loan loss rates by roughly 0.4 percentage points.
  - These increases are comparable to loan loss increases experienced during the 2014–16 oil price decline.

### Macroprudential Policy and Systemic Risk Oversight — Institutional Setup and Recommendations
- Institutional setup:
  - MoF is the single ultimate macroprudential decision-maker; Norges Bank and FSA advise and operate most tools.
  - Coordination relies mainly on informal traditions; semiannual triparty meetings exist but their role in policy formation is limited.
- Key tool history:
  - CCyB introduced in 2015 and raised three times to 2½ percent by end-2019; reduced to 1 percent in March 2020.
  - SRB introduced in 2013 initially at 2 percent, raised to 3 percent in 2014; authorities envisaged raising SRB to 4½ percent from end-2020 while narrowing its basis to domestic exposures.
  - Borrower-based measures: DTI limit of 500 percent; LTV limits including 85 percent general and 60 percent for secondary homes in Oslo; flexibility quota (“speed limit”) normally 10 percent (8 percent in Oslo), temporarily increased to 20 percent for 2020Q2.
- Recommendations:
  - Develop and publish a macroprudential policy strategy. (MoF, Norges Bank, FSA) — ST
  - Use semiannual triparty meetings more effectively. (MoF, Norges Bank, FSA) — I
  - Give Norges Bank recommendation powers over tools that can be relaxed, with a comply-or-explain mechanism. (MoF) — I
  - Make key household sector measures permanent features of the framework. (MoF) — ST
  - Consider broadening toolkit for CRE risks, including sectoral capital tools. (MoF) — MT

### Banking and Insurance Supervision (Microprudential) — Findings and Recommendations
- FSA strengths and weaknesses:
  - FSA has solid supervisory framework and powers, with improvements since last FSAP.
  - Weaknesses: limited operational independence (MoF sets budget, can issue instructions, grant/revoke licenses, and overturn supervisory decisions); supervisory focus concentrated on largest domestic banks with less coverage of medium/smaller banks and foreign branches.
- Banking supervision recommendations:
  - Strengthen FSA independence: grant powers to issue binding regulations, decide on bank licenses/withdrawal, limit MoF’s instruction powers, and provide budgetary autonomy. (MoF) — ST
  - Expand supervisory coverage to high-risk medium and small institutions and increase direct monitoring and on-site supervision of foreign branches. (FSA) — ST
  - Further enhance oversight of IRB models in view of CRD IV implementation. (FSA) — I
  - Intensify oversight of banks’ risk management for real estate loans and funding/liquidity conditions. (FSA) — ST
  - Develop supervisory guidance on loan loss provisioning and valuation of real estate; make temporary RRE and consumer loan regulations permanent.
- Insurance sector recommendations:
  - Strengthen risk-monitoring of individual insurers and group/industry-wide levels. (FSA) — ST
  - Conduct Norway-specific in-house market-wide stress tests of the insurance sector to complement EIOPA. (FSA) — MT
  - Monitor banking-insurance conglomerates and broaden supervision metrics beyond market share and solvency ratio.

### Cybersecurity Supervision — Findings and Recommendations
- Framework:
  - Norway’s cybersecurity risk mitigation framework is mature and advanced; threat-intelligence and crisis management platforms are well developed.
  - Concern: outsourcing of IT services by critical payment systems to external service providers not directly supervised.
- Recommendations:
  - Make cybersecurity risk supervision processes more structured and comprehensive. (FSA, Norges Bank) — I
  - Establish incident reporting and crisis management frameworks for systemic cyber incidents. (FSA, Norges Bank) — ST
  - Improve collection, sharing, and handling of information on cybersecurity incidents.
  - Strengthen Norges Bank’s cyber oversight of payment systems, including mandating audits or on-site inspections of critical service providers.

### Resolution, Crisis Management, and Systemic Liquidity
- Resolution and crisis preparedness:
  - Make new resolution tools operational without delay; clarify statutory resolution objectives and accountability for FSA as resolution authority.
  - Ensure stronger integration of the Banks’ Guarantee Fund (BGF) into the resolution framework; exclude active bankers from the BGF Board; BGF should not provide open bank assistance.
  - Prioritize build-up of MREL, including subordinated component; prepare practical execution of bail-in tool.
  - Make the resolution fund operational and continue crisis simulation exercises.
- Norges Bank liquidity operations and nonstandard collateral:
  - Norges Bank has effective operations in normal times; policy rate correlated with NOWA; NOWA spikes at quarter-end suggest behavioral incentives from leverage ratio requirements — consider quarterly averaging of leverage ratio requirement.
  - Norges Bank can provide ELA in foreign currency and has a market-wide liquidity support framework; COVID-19 response included extended NOK and USD lending operations and a US$30 billion Fed swap line.
  - Recommendation: analyze and monitor availability of eligible collateral across counterparties and complete work to facilitate acceptance of loan portfolios as nonstandard collateral for emergency liquidity support.

### Data Collection and Financial Stability Analysis
- Recommended improvements:
  - Collect data on liquidity positions of foreign bank branches and expand CRE data gathering.
  - Maintain accurate and updated maps of internal composition of borrower groups.
  - Accelerate improved data collection for derivatives transactions, margining arrangements and counterparty risk.
  - Collect more granular bank lending data to develop detailed credit risk models.

### Key Statistics and Factual Highlights (selected exact figures)
- Policy rate: zero percent (from 1.5 percent) after three cuts.
- US dollar swap line with Federal Reserve: up to US$30 billion.
- CCyB: relaxed from 2.5 percent to 1 percent; no increase anticipated until at least Q1 2022.
- Temporary mortgage deviation allowance: up to 20 percent of new loans during 2020Q2 (previously 10 percent; 8 percent in Oslo).
- Financial sector assets (excluding GPF-G): 290 percent of GDP.
- GPF-G assets as of mid-2019: 260 percent of GDP.
- Number of commercial banks: 135.
- Banking sector asset shares: banks 54 percent; mortgage companies 23 percent; insurers 18 percent; state-lending institutions 3 percent; finance companies 2 percent.
- Banks’ total regulatory capital ratio: 24.2 percent (end-2019).
- Banks’ CET1 ratio: 18.0 percent (end-2019).
- NPLs overall: below one percent; consumer debt NPLs 11 percent at end-2019 (consumer debt is four percent of bank lending).
- Provisions cover about 85 percent of NPLs.
- Solvency stress test horizon: 3-year.
- Top-down sample: 11 largest domestic banks covering about 80 percent of domestic banking assets and 60 percent of total banking system assets.
- Stress-test hurdle rates average: about 10 percent.
- COVID central scenario GDP contraction (2020): almost 5½ percent.
- COVID downside scenario GDP contraction (2020): about 7 percent.
- Market shock scenario: RRE prices decline by 35 percent; CRE prices decline by more than 50 percent; equity prices fall by 40 percent; oil price to US$27 per barrel.

### Macro-Financial Scenarios — Key Variable Paths (exact values)
- Real GDP - Mainland (y/y percent change):
  - COVID Baseline: 2020 -5.5, 2021 3.8, 2022 3.3
  - COVID Downside: 2020 -7.1, 2021 2.6, 2022 0.6
  - Market Shock: 2020 -1.9, 2021 -3.3, 2022 0.5
- Unemployment rate:
  - COVID Baseline: 2020 8.2, 2021 6.6, 2022 4.5
  - COVID Downside: 2020 8.8, 2021 7.2, 2022 5.1
  - Market Shock: 2020 5.9, 2021 8.9, 2022 9.3
- Consumer price index (y/y percent change):
  - COVID Baseline & Downside: 2020 2.5, 2021 2.8, 2022 2.0
  - Market Shock: 2020 2.1, 2021 2.2, 2022 2.2
- Crude oil price (US$ per barrel):
  - COVID Baseline: 2020 36.2, 2021 37.5, 2022 40.8
  - COVID Downside: 2020 24.1, 2021 19.5, 2022 19.0
  - Market Shock: 2020 34.0, 2021 27.0, 2022 26.0
- Equity index (OSEAX):
  - COVID Baseline: 2020 -24.2, 2021 35.3, 2022 30.7
  - COVID Downside: 2020 -39.1, 2021 20.2, 2022 14.1
  - Market Shock: 2020 -33.0, 2021 -10.0, 2022 14.0
- House price index (y/y percent change):
  - COVID Baseline: 2020 0.8, 2021 7.5, 2022 7.1
  - COVID Downside: 2020 -1.8, 2021 7.2, 2022 6.0
  - Market Shock: 2020 -16.6, 2021 -11.9, 2022 -11.2
- 3-month money market rate (average):
  - COVID Baseline & Downside: 2020 1.0, 2021 0.3, 2022 0.3
  - Market Shock: 2020 2.2, 2021 2.6, 2022 2.9

### Authorities' Response and Views (summary)
- Authorities welcome FSAP analyses and recommendations, noting many recommendations remain valid despite COVID-19.
- Authorities emphasize need to respect institutional roles and democratic legitimacy when considering increased FSA independence and new coordinating bodies.
- Finanstilsynet has begun sanctioning non-compliance since June 2019 and the government published a new AML/CFT strategy.
- Authorities note ongoing support measures have mitigated the downturn, credit growth has fallen, credit losses increased, and housing market rebounded after a sharp March fall.

*Source: EXECUTIVE SUMMARY and selected excerpts (1norea2020001).*

### EXECUTIVE SUMMARY __________________________________________________________________________ 6

### EXECUTIVE SUMMARY

### Background and Context
- Norway is a major oil exporter with significant financial buffers: about US$1 trillion in assets, or about 260 percent of GDP.
- Public finances were in rude health at the onset of the COVID-19 pandemic; social safety nets are strong.
- Long-term structural headwinds: population aging, slow productivity growth, and an anticipated decline in oil production.
- Much of the 2020 FSAP work was conducted prior to the COVID-19 outbreak; findings and recommendations remain pertinent and the risk assessment quantifies the impact of the COVID-19 crisis on bank solvency.

### Macrofinancial Developments
- Economic performance and policy moves:
  - Following the 2014 oil-price drop, growth recovered during 2016–18 supported by rebounding oil prices, accommodative policies, and krone depreciation.
  - The global COVID-19 shock from late February 2020 caused a sharp decline in economic activity, a spike in unemployment, and substantial further depreciation of the krone.
  - Norges Bank had raised its key policy rate four times between September 2018 and September 2019, to 1.5 percent, and cut rates to zero percent in March–May 2020 in three steps.
- Real estate and debt trends:
  - Residential real estate (RRE) prices increased by 70 percent over the last decade; in Oslo they doubled.
  - Household debt levels now exceed 200 percent of disposable income on average.
  - The share of households with debt levels exceeding five times their gross income has been rising.
  - Commercial real estate (CRE), especially Oslo’s prime office market, has also boomed.
  - Corporate debt levels are about average in international peer comparison.

### Financial System Structure and Developments
- Post-2015 reforms:
  - Regulatory capital requirements for banks were raised.
  - Actions were taken to bolster the weak capital position of insurers.
  - Temporary borrower-based measures for residential mortgages were introduced and appear to have had some moderating impact on segments of the housing market.
  - The resolution framework was strengthened with implementation of the Bank Recovery and Resolution Directive (BRRD) and designation of Finanstilsynet (FSA) as the resolution authority.
- Remaining vulnerabilities:
  - High bank exposure to real estate risks amid elevated RRE valuations and high household debt.
  - Banks’ reliance on international wholesale funding markets.
  - Emergence of new risks from a tight CRE market.
  - Some key weaknesses identified in the 2015 FSAP remain only partly addressed.

### Systemic Risk Analysis and Stress Testing
- Solvency and liquidity stress tests:
  - Solvency stress tests show resilience of the banking sector under COVID and market risk scenarios; however, in the most severe scenario a few banks would exhaust their capital buffers above the hurdle rates of about 10 percent CET1 ratio.
  - Banks’ liquidity positions are generally robust in the short-term, but risks become significant over longer horizons.
  - The stress tests highlight the sizable impact that shocks—such as the COVID-19 pandemic—can have and underscore the importance of continued strong financial sector policies.

### Climate-Related Transition Risk
- Assessment findings:
  - Sharp increases in carbon prices would have a significant but manageable impact on banks’ loan losses.
  - Following a price hike for corporate carbon emissions, banks’ overall debt-at-risk would remain small, though the impact varies across banks.
  - A permanent fall in global oil demand due to higher carbon prices would lead to loan losses for banks comparable to those experienced during the 2014–16 oil price decline.
  - Given Norway’s role as a major oil producer, transition risks to higher carbon prices are important.

### Macroprudential Policy and Systemic Risk Oversight
- Strengthening the macroprudential framework:
  - Develop and publish a macroprudential policy strategy to foster accountability, facilitate communications, and prepare the market for adjustments of bank capital and liquidity buffers.
  - Use semiannual triparty meetings (MoF, Norges Bank, FSA) more effectively to jointly discuss risks and specific policy actions.
  - Give Norges Bank recommendation powers over capital and liquidity tools that can be relaxed, with a comply-or-explain mechanism.
  - Make temporary borrower-based measures for RRE permanent features of the framework.
  - Consider broadening the toolkit for addressing CRE risks, including sectoral capital tools.

### Banking and Insurance Supervision (Microprudential)
- FSA capacity and priorities:
  - Strengthen the FSA’s prudential powers, operational independence, and budgetary autonomy.
  - Expand review of banks’ risks in supervisory activities to strengthen oversight over systemic foreign bank branches and domestic medium and small sized banks.
  - Intensify oversight of banks’ risk management of real estate loans and funding/liquidity conditions.
  - Further enhance oversight of banks’ Internal Ratings-Based (IRB) models in view of the implementation of CRD IV.
- Insurance sector:
  - Strengthen risk-monitoring of individual insurers.
  - Complement EIOPA efforts with Norway-specific in-house stress tests of the whole insurance sector.

### Cybersecurity Supervision
- Current framework and recommended improvements:
  - Norway’s cybersecurity risk mitigation framework is advanced but potential threats are evolving rapidly.
  - Make processes for cybersecurity risk supervision and oversight more structured and comprehensive (FSA, Norges Bank).
  - Establish incident reporting and crisis management frameworks for systemic cyber incidents (FSA, Norges Bank).
  - Improve collection, sharing, and handling of information on cybersecurity incidents.
  - Strengthen Norges Bank’s cyber security oversight of payment systems and monitor critical service providers for payment systems more closely, including by mandating audits or on-site inspections.

### Resolution, Crisis Management, and Systemic Liquidity
- Resolution framework:
  - Make the new resolution tools operational without delay and strengthen the crisis preparedness framework.
  - The FSA, as the resolution authority, would benefit from clearly defined statutory resolution objectives and accountability.
  - Ensure stronger integration of the Banks’ Guarantee Fund (BGF) into the resolution framework.
- Crisis management coordination:
  - Establish an overarching coordinating body with a mandate for system-wide coordination of activities related to crisis prevention and management.
  - Strengthen cross-border crisis management arrangements within the Nordic-Baltic region for Norway as host to significant foreign bank branches.
- Systemic liquidity:
  - Monitor banks’ collateral eligible for central bank liquidity (Norges Bank).
  - Develop, test and implement a mechanism for acceptance of mortgage loan collateral for emergency liquidity support to solvent banks (Norges Bank).

### Data Collection and Financial Stability Analysis
- Recommended data improvements:
  - Collect data on the liquidity position of foreign bank branches and expand data gathering on commercial real estate.
  - Maintain accurate and updated “maps” of the internal composition of borrower groups.
  - Accelerate improved data collection for derivatives transactions and related counterparty risk.
  - Seek to collect more granular data on bank lending to allow further development of models of banks’ credit risk.
  - Improve collection and analysis of derivatives exposure data and analyze banks’ margin arrangements.

### Key Recommendations (selected from Table 1)
- Systemic Risk Oversight and Macroprudential Policy:
  - Develop and publish a macroprudential policy strategy. (MoF, Norges Bank, FSA) — ST
  - Use existing triparty meetings more effectively to discuss risks and policy actions needed to address them. (MoF, Norges Bank, FSA) — I
  - Give Norges Bank recommendation powers over macroprudential policy tools that can be relaxed under stress, with a comply-or-explain mechanism. (MoF) — I
  - Make key household sector measures permanent features of the framework. (MoF) — ST
  - Consider broadening the toolkit for mitigating CRE vulnerabilities, including sectoral capital tools. (MoF) — MT
- Banking and Insurance Supervision:
  - Strengthen the FSA’s prudential powers, operational independence, and budgetary autonomy. (MoF) — ST
  - Expand review of banks’ risks in supervisory activities to strengthen oversight over systemic foreign bank branches and domestic medium and small sized banks. (FSA) — ST
  - Further enhance the oversight of banks’ IRB models, in view of the implementation of CRD IV. (FSA) — I
  - Intensify oversight of banks’ risk management of real estate loans and funding/liquidity conditions. (FSA) — ST
  - Strengthen risk-monitoring of individual insurers. (FSA) — ST
  - Complement EIOPA efforts with Norway-specific in-house stress tests of the whole insurance sector. (FSA) — MT
- Cybersecurity Supervision:
  - Make processes for cybersecurity risk supervision and oversight more structured and comprehensive. (FSA, Norges Bank) — I
  - Establish incident reporting and crisis management frameworks for systemic cyber incidents. (FSA, Norges Bank) — ST
- AML/CFT Supervision:
  - Enhance AML/CFT supervision by increasing the frequency of targeted and thematic inspections and improving the risk-based approach and tools for AML/CFT risk assessments. (FSA) — I
  - Ensure appropriate use of sanctions, including monetary penalties, for AML/CFT violations. (FSA) — I
- Financial Crisis Management and Safety Nets:
  - Make the new resolution tools operational and strengthen the crisis preparedness framework. (FSA, MoF) — ST
  - Ensure BGF’s integration into the broader resolution framework. (BGF, FSA) — ST
- Systemic Liquidity and Financial Stability Analysis:
  - Monitor banks’ collateral eligible for central bank liquidity. (Norges Bank) — ST
  - Develop, test and implement a mechanism for acceptance of mortgage loan collateral for emergency liquidity support to solvent banks. (Norges Bank) — ST
  - Upgrade data collection for risk monitoring to include more granular data on bank lending (including for commercial real estate), group mappings, and liquidity positions of foreign branches. (FSA, Norges Bank) — ST
  - Improve collection and analysis of derivatives exposure data and analyze banks’ margin arrangements. (FSA, Norges Bank) — ST

*Source: EXECUTIVE SUMMARY (1norea2020001).*

### Box 1. Norway’s Financial Sector Policy Response to COVID-19

### Box 1. Norway’s Financial Sector Policy Response to COVID-19

### Key policy measures to safeguard financial stability
- Monetary policy:
  - Three rate cuts brought the main policy rate to zero percent (from 1.5 percent).
  - Norges Bank provided extraordinary NOK loans with maturities ranging from 1-week to 1-year with full allotment; collateral requirements were eased by removing limits on use of non-government securities.
  - The FSA underscored that use by banks of high-quality liquid assets held to satisfy the LCR requirement is permitted, provided it is properly reported.
  - Norges Bank agreed a US dollar swap line with the Federal Reserve for up to US$30 billion and has provided US dollar liquidity to Norwegian banks.
- Macroprudential:
  - Countercyclical capital buffer (CCyB) relaxed from 2.5 percent to 1 percent to ease constraints on bank lending.
  - Authorities indicated no increase in the CCyB is anticipated until at least the first quarter of 2022.
  - Mortgage lending regulation temporarily allowed banks to deviate from LTV, DTI, and other requirements for up to 20 percent of new loans during 2020Q2, compared to a previous “speed limit” of 10 percent (8 percent in Oslo).
- Microprudential:
  - FSA and MoF appealed to banks and insurers to restrict dividend payouts until economic uncertainty is reduced.
  - Regulatory reporting of short sales of domestic equity shares has been enhanced.

### Financial system structure and vulnerabilities
- Size and composition:
  - Financial sector assets, excluding the globally-invested government pension fund (GPF-G), total 290 percent of GDP.
  - The GPF-G is another 260 percent of GDP as of mid-2019.
  - The financial sector comprises 135 commercial banks (54 percent of financial system assets), mortgage companies (23 percent), insurers (18 percent), state-lending institutions (3 percent), and finance companies (2 percent).
  - Branches of foreign banks account for about one-quarter of banking system assets, making up about 35 percent of lending to corporates and 20 percent of retail lending.
- Capitalization, liquidity, and asset quality (pre-COVID):
  - Banks’ total regulatory capital ratio was 24.2 percent as of end-2019, with a Common Equity Tier 1 Capital Ratio (CET1) of 18.0 percent.
  - Two domestic systemically important credit institutions face an additional two percent requirement.
  - Liquidity coverage ratio (LCR) requirements were in full compliance; liquidity coverage in foreign currencies generally exceeds that in Norwegian krone.
  - Nonperforming loans (NPLs) were below one percent overall; NPLs on consumer debt (four percent of bank lending) were 11 percent at end-2019.
  - Banks’ provisions provide about 85 percent coverage of NPLs.
- Funding and exposures:
  - Close to 60 percent of banks’ lending is related to residential and commercial real estate, with most loans at variable-rates.
  - Norwegian banks obtain nearly half their overall funding from wholesale markets.
  - About two-thirds of wholesale funding comes from covered bonds, with substantial cross-ownership of covered bonds between banks.
- Structural and operational risks:
  - Key vulnerabilities: high exposures to domestic real estate and wholesale funding.
  - Other significant risks: transition risk from an abrupt move to a low-carbon economy given Norway’s reliance on oil production/export; cybersecurity threats affecting a mostly cashless system; financial integrity risks (e.g., alleged breach of customer due diligence rules at DNB).

### Stress testing, scenarios, and results
- Scope and methodology:
  - Top-down solvency exercise analyzes risks over a 3-year horizon and includes the 11 largest domestic banks, which account for about 80 percent of domestic banking assets (i.e., excluding Norwegian assets of branches of foreign banks) and 60 percent of total banking system assets.
  - The hurdle rate for the exercises includes all capital requirements and buffers after adoption of the European capital framework but excluding the Capital Conservation Buffer (CCB) and the Countercyclical Capital Buffer (CCyB); hurdle rates average about 10 percent.
  - Stress tests include both COVID scenarios and a market shock scenario from the FSAP.
- COVID-19 solvency stress test scenarios:
  - COVID central scenario: reflects the projected baseline outlook as of June 2020; Norwegian mainland GDP contracts by almost 5½ percent in 2020. The economy starts to rebound from the second half of 2020.
  - COVID downside scenario: approximated by a downward divergence of 1 standard deviation of the core variables, resulting in a GDP decline of about 7 percent in 2020 and a more gradual recovery.
  - Results: at the end of the risk horizon aggregate CET1 ratio for the in-sample banks drops by about 4 percent under the central scenario and 4½ percent under the downside scenario. Under the COVID downside scenario, one bank would exhaust its buffers in excess of the hurdle rate, though without breaching it.
  - The COVID scenarios show a somewhat less severe impact than the market shock scenario because of a faster recovery and easier financial conditions.
- Market shock solvency stress test:
  - Scenario assumptions: multi-year recession causing a fall in the level of GDP of over 5 percent by the second year (an almost 3 standard-deviation shock), limited recovery in the third year; property prices decline by 35 percent for RRE and by more than 50 percent for CRE; equity prices fall by 40 percent over the first two years; oil price drops to US$27 per barrel.
  - No policy response is assumed to allow a clear view on the impact of the shock.
  - Outcome: the market shock scenario leads to a significantly larger impact on banks’ capital in the second and third years compared with the COVID scenarios.

### Key statistics and factual highlights
- Policy rate: zero percent (from 1.5 percent) after three cuts.
- US dollar swap line with Federal Reserve: up to US$30 billion.
- CCyB: relaxed from 2.5 percent to 1 percent; no increase anticipated until at least Q1 2022.
- Temporary mortgage deviation allowance: up to 20 percent of new loans during 2020Q2 (previously 10 percent; 8 percent in Oslo).
- Financial sector assets (excluding GPF-G): 290 percent of GDP.
- GPF-G assets as of mid-2019: 260 percent of GDP.
- Number of commercial banks: 135.
- Banking sector asset shares: banks 54 percent; mortgage companies 23 percent; insurers 18 percent; state-lending institutions 3 percent; finance companies 2 percent.
- Banks’ total regulatory capital ratio: 24.2 percent (end-2019).
- Banks’ CET1 ratio: 18.0 percent (end-2019).
- NPLs overall: below one percent; consumer debt NPLs 11 percent at end-2019 (consumer debt is four percent of bank lending).
- Provisions cover about 85 percent of NPLs.
- Solvency stress test horizon: 3-year.
- Top-down sample: 11 largest domestic banks covering about 80 percent of domestic banking assets and 60 percent of total banking system assets.
- Stress-test hurdle rates average: about 10 percent.
- COVID central scenario GDP contraction (2020): almost 5½ percent.
- COVID downside scenario GDP contraction (2020): about 7 percent.
- Market shock scenario: GDP fall of over 5 percent by second year; RRE prices decline by 35 percent; CRE prices decline by more than 50 percent; equity prices fall by 40 percent; oil price to US$27 per barrel.

*International Monetary Fund*

### 20.      Under the market shock scenario, the banking system is hit hard. NPL ratios would

### 1norea2020001 - 20. Under the market shock scenario, the banking system is hit hard. NPL ratios would

### Market shock scenario: solvency outcomes
- NPL ratios would increase substantially, "up to levels not seen since the mid-1990s."
- Loan losses would rise across all sectors; the mining sector (including oil extraction and related services) and transport and storage are particularly affected.
- The real estate slump accounts for about 30 percent of overall losses.
- Assumption: about three-quarters of the losses from retail loan portfolios are related to mortgages.
- Loan loss provisions are the primary drain on capital, with additional losses from debt and equity portfolios and increases in Risk-Weighted Assets.
- Average drop in the CET1 ratio by the end of the risk horizon:
  - FSAP top-down average: 5 percentage points.
  - Norges Bank estimate: on the order of 6.2 percentage points.
- FSAP top-down test results:
  - No material breaches of the hurdle rates in the FSAP and FSA exercises.
  - Buffers in excess of the hurdle rates would be depleted only partially for most banks and fully for three of them.
- Bottom-up stress tests (three largest banks) project declines in capital ratios that are more contained than top-down exercises.
- Sensitivity analysis on securities market risk indicates risks from banks’ securities holdings are largely contained.
- Bottom-up sensitivity tests of interest rate and FX risks show low levels of risk, consistent with hedging.

### Liquidity stress tests: short-term resilience, longer-term tensions
- Scope: liquidity of 11 banks assessed (same sample as top-down solvency stress test).
- LCR (1-month horizon):
  - Tests combined three "haircut" scenarios with seven "outflow" scenarios.
  - In all individual scenarios, the average LCR for the 11 banks would remain above 100 percent over a one-month horizon, though some banks would breach the threshold under more severe scenario combinations.
  - LCR in domestic currency (50 percent floor applies for some banks) remains above the threshold on average; only one bank experiences difficulties under a severe scenario combination.
  - Norwegian banks’ LCR in EUR and USD remains well above 100 percent in all cases.
- Cash flow analysis (up to one year, 18 maturity buckets):
  - Under a mildly adverse scenario, all banks would comfortably handle net outflows up to one year with their initial counterbalancing capacity.
  - Under a severely adverse scenario, some banks would encounter difficulties; starting from the 3–4 months bucket, the whole system would experience counterbalancing capacity gaps.
  - Debt issuance plays a delicate role, highlighting rollover risks under capital market dislocations.
  - Difficulties in rolling over derivative transactions for hedging interest rate and FX risks also contribute to liquidity shortages; possible margin calls could compound difficulties (detailed assessment requires transaction-level data not available).

### Interconnectedness and contagion
- Partial analysis of Nordic-region bank linkages (market-valuation spillovers) shows interconnectedness remains important but varies over time; some weakening of links since 2017.
- Analysis is partial and may not capture derivatives exposures, which are likely important and significantly concentrated.
- Norges Bank assessment: direct and indirect contagion effects within the banking sector could amplify capital depletion under stress by 1 percent on average and up to 2.5 percent in the worst case considered.

### Climate transition risk: two partial-equilibrium analyses
- Transition risks (policy and technology changes) are more material for Norway than physical climate risks due to Norway’s role as a major oil and gas producer.
- Two questions addressed:
  1. How would an increase in domestic carbon prices impact banks’ credit exposures?
  2. How would a fall in oil sector revenues affect banks’ loan losses?
- Carbon price simulations: average carbon price increases to US$75 and US$150.
  - Firm-level balance sheet approach calculates banks’ debt-at-risk (share of exposures where the interest coverage ratio drops below a threshold).
  - Firms in emission-intensive sectors (e.g., waste management and transportation) would be materially impacted.
  - Banks’ increase in debt-at-risk remains small on average but significant for banks with lending concentrated in exposed sectors.
- Permanent fall in global oil demand (via higher global carbon taxes) estimated effects:
  - Carbon price of US$75: estimated increase in loan loss rates by about 0.3 percentage points (a doubling from pre-COVID levels).
  - Carbon price of US$150: estimated increase in loan loss rates by roughly 0.4 percentage points.
  - These results are comparable to the increase in loan loss rates experienced during the oil price decline of 2014–16, though dynamics may differ because of the perceived persistence of a policy-driven shock.

### Risk monitoring and data gaps
- Recommended data and analytical enhancements:
  - Establish regular collection of data on the liquidity position of foreign bank branches.
  - Maintain accurate and updated maps of the internal composition of borrower groups.
  - Accelerate data collection and methodological steps to analyze margining arrangements for derivative transactions and related counterparty risk.
  - Develop more analytical and granular models for credit risk at the bank and asset-class levels.

### Macroprudential policy: institutional setup, tools, and recommendations
- Institutional setup:
  - The Ministry of Finance (MoF) is the single ultimate macroprudential decision-maker in Norway; Norges Bank and the FSA play advisory roles and operate most policy tools.
  - Coordination relies mostly on informal traditions; biannual triparty meetings exist but play a limited role in policy formation.
- Recent policy actions demonstrate willingness and ability to act; Norway has taken substantive and wide-ranging measures over the past decade.
- Broad-based capital tools:
  - Countercyclical capital buffer (CCyB) introduced in 2015; raised three times to reach 2½ percent from end-2019.
  - CCyB reduced to 1 percent in March 2020.
  - Systemic risk buffer (SRB) introduced in 2013:
    - Initially set at 2 percent over all banks’ exposures.
    - Raised in 2014 to 3 percent.
    - Authorities had envisaged raising the SRB further to 4½ percent from end-2020, though narrowing its basis to domestic exposures only.
  - Active use of capital tools contributed to banks’ high capital levels, providing valuable buffers during the COVID-19 shock.
- Borrower-based household measures:
  - Prior mortgage guidelines (LTV limits and stressed financial margins) converted into binding regulations; regulations expire periodically (12 or 18 months) and have been renewed to date.
  - Debt-to-income (DTI) limit of 500 percent; tighter underwriting restrictions for Oslo.
  - Flexibility quota ("speed limit"): allows banks to deviate from requirements for 10 percent of lending (8 percent in Oslo) during normal times.
  - In response to COVID-19, flexibility quota temporarily increased to 20 percent for all new loans extended during 2020Q2.
- Commercial real estate (CRE) measures:
  - 100 percent risk-weight floor on CRE exposures for banks using the standardized approach introduced in 2014.
  - Intensified oversight and Pillar II capital add-ons for banks with concentrated exposures in 2018.
  - New temporary risk weight floor for CRE of 35 percent for IRB banks slated to become effective end-2020 (as part of measures to offset weakening of capital requirements implied by adoption of EU rules).
- Policy and institutional recommendations:
  - Develop and publish a macroprudential policy strategy to help guard against inaction bias, foster accountability, facilitate external communications, and prepare the market for buffer adjustments.
  - Use semiannual triparty meetings more effectively to jointly discuss risks and specific policy actions.
  - Give Norges Bank recommendation powers, with a comply-or-explain mechanism, over tools that can be relaxed (e.g., the SRB and the LCR in significant currencies) to bolster the macroprudential perspective in times of systemic distress; this would complement Norges Bank’s existing recommendation powers over the CCyB.
  - Make key elements of the temporary household measures permanent features of the framework; the duration of these measures should match the structural nature of the risks they address.

*International Monetary Fund — Norway FSAP excerpts (market shock, liquidity stress tests, interconnectedness, climate transition risk, macroprudential policy).*

### 35.      Although CRE market risks are now on the downside, broadening the toolkit for CRE

### 35.      Although CRE market risks are now on the downside, broadening the toolkit for CRE

### CRE vulnerabilities and targeted macroprudential toolkit
- CRE market risks are currently on the downside, but broadening the toolkit for CRE vulnerabilities could help address these in a more targeted manner during future upswings.
- Authorities should consider:
  - Introduction of a sectoral CCyB (sectoral countercyclical capital buffer), which has been used effectively in Switzerland.
  - Introduction of a sectoral SRB (sectoral systemic risk buffer) to specifically address banks’ CRE exposures.
- Purpose: Targeted tools would help contain CRE risks without imposing undue costs on banks with low CRE exposures.

### Data collection to support systemic risk analysis and calibration
- Data quality and availability is generally good; recent progress includes the establishment of a credit registry for consumer lending.
- Remaining data gaps:
  - Need to collect data on NPLs and financial distress for households to guide calibration of borrower-based tools.
  - Need for more granular and comparable data on CRE to facilitate monitoring and analysis and possible future development of new instruments.

### B. Banking Sector Supervision — main findings
- The FSA has thorough supervisory processes and tools, with key improvements in recent years:
  - Oversight framework is solid; FSA has required supervisory powers to limit or address unsound bank practices and risk-taking.
  - Improvements since the last FSAP included adoption of higher regulatory capital requirements, key updates to supervisory modules, new temporary requirements for RRE and consumer loans, and full phase-in of the LCR.
- Remaining weaknesses:
  - Limited operational independence: the MoF sets the FSA’s budget and can decide on prudential regulations, set goals and issue instructions, grant and revoke bank licenses, and overturn the FSA’s supervisory decisions.
  - Supervisory focus concentrated on largest domestic banks; less focus on medium and smaller-sized banks and on prudential oversight of foreign bank branches, which is primarily conducted by home supervisors with the FSA engaging via cross-border cooperation and supervisory colleges.

### B. Banking Sector Supervision — recommendations
- Strengthen FSA independence:
  - Grant the FSA powers to issue binding regulations and to decide on bank licenses and their withdrawal.
  - Limit the MoF’s powers to issue instructions to the FSA and decide on appeals to FSA supervisory decisions.
  - Provide more budgetary autonomy for the FSA, paired with a higher level of accountability.
- Enhance supervisory coverage and oversight:
  - Give greater consideration to banks’ risk profiles when planning and performing supervisory activities to better cover high-risk medium and small-sized institutions.
  - Increase direct monitoring and onsite supervision of foreign branches, especially systemic ones.
  - These improvements may require increased FSA resources, which underscores the importance of more budgetary autonomy.
- Maintain strong capital levels after adoption of EU rules:
  - Adoption of the EU capital adequacy framework in 2020 represents a weakening of existing requirements in Norway (including removal of the Basel I floor and introduction of the supporting factor for loans to SMEs) and limits room for maneuver under Pillar 1.
  - The MoF increased some capital requirements; the FSA has initiated steps to enhance IRB models for credit risk.
  - The mission supports these efforts and encourages monitoring of transposition implications and actions as needed to maintain strong capital levels.
  - The FSA should continue to enhance oversight of banks’ IRB models and provide banks with a transparent and detailed description of its Pillar 2 approach and decisions.
- Bolster credit risk regulatory framework and oversight:
  - Develop supervisory guidance on prudential aspects of loan loss provisioning and valuation of real estate.
  - Make the temporary prudential regulations for residential real estate and consumer lending permanent.
  - Develop supervisory guidance on CRE exposures to supplement intensified supervisory scrutiny.
- Strengthen liquidity and funding oversight:
  - Extend liquidity oversight beyond existing LCR requirements; introduce NSFR as a requirement according to the EU framework timeline (NSFR currently reported by banks).
  - Further enhance oversight of banks’ liquidity and funding risk management given significant reliance on covered bonds and more lenient treatment of such instruments in the European LCR framework.
  - Concern: cross-holdings of covered bonds among banks and their link with the real estate market may exacerbate risks.

### C. Insurance Sector Supervision — key facts
- Sector size and composition:
  - Balance sheet assets of NOK 1820 billion, or about 18 percent of the total financial system.
  - Life insurance business, including pensions, accounts for 90 percent of the sector.
  - Non-life (property and casualty) makes up the remaining 10 percent.
  - Many insurers are part of broader conglomerates.
- Capital and business-model adjustments:
  - Capital levels of insurers have improved significantly in recent years through greater profit retention, issuance of subordinated debt, reduced costs, and lowered investment risk.
  - Life insurers have ceased offering or significantly reduced products with interest rate guarantees; transition from defined-benefit to defined-contribution schemes is reducing long-run solvency risks.
  - Legacy guarantees continue to affect insurers’ solvency position for a considerable time.

### C. Insurance Sector Supervision — recommendations
- Enhance risk analysis and supervision:
  - Strengthen risk-monitoring at group and industry-wide levels to better cover systemic risks.
  - Conduct FSA-led market-wide stress tests of the insurance sector (instead of relying on EIOPA exercises that cover only the two largest insurers).
  - Monitor banking-insurance conglomerates more closely to assess aggregation of counterparty linkages and common exposures.
- Broaden risk measures guiding supervision:
  - In addition to market share and solvency ratio, consider adding metrics for market risk, credit risk, profitability, liquidity, and quality of risk management and governance to better capture current risk levels and their evolution.
- Contain housing-related exposures and regulatory arbitrage:
  - Recent steps to make capital requirements on holdings of mortgage portfolios more consistent for banks and insurers are welcome.
  - The FSA should consider establishing a comprehensive monitoring and reporting framework to track the evolution of the real estate market and risks from residential mortgage lending faced by individual insurers.
  - Monitor how new rules affect insurers’ and conglomerates’ investment behaviors.

### D. Cyber Resilience — main findings
- Norway’s cybersecurity risk mitigation framework is mature and advanced:
  - Norway has been at the forefront of digitalization of payments and financial services, increasing cyber threats.
  - Concern: outsourcing of IT services by critical payment systems to external service providers not directly supervised by authorities.
  - Threat-intelligence collection and crisis management platforms used by financial institutions and FMIs are well developed.
  - Cybersecurity risk regulation and supervisory practices are generally sound.
  - The FSA has adequate regulatory tools and expertise, though cyber expertise at the payment systems oversight function in Norges Bank is comparatively less developed.
- Areas for further improvement:
  - Incident reporting and crisis management for systemic cyber incidents:
    - Improve incident-reporting framework by setting clearer qualitative or quantitative thresholds for cyber incidents and further defining processes and formats for incident reporting.
    - Establish information sharing agreements on cybersecurity incidents between Norges Bank and the FSA and a clearly defined crisis management framework to maintain financial stability if systemic cyber incidents occur.
  - Cybersecurity risk supervision at the FSA:
    - Adopt a more structured and comprehensive approach, including a clear description of off-site supervision on cybersecurity and how assessments influence overall risk assessments.
    - Issue additional enforceable guidance on IT/cybersecurity risk and increase the intrusiveness of on-site cybersecurity inspections.
  - Norges Bank oversight of payment systems:
    - Intensify cybersecurity risk oversight by utilizing a portfolio of tools and techniques to assess cybersecurity risk against set expectations, reach clear conclusions, and identify specific remedial measures.
    - Provide further cybersecurity training for overseers and clearly communicate expectations to the market, supplementing CPMI-IOSCO guidance, to increase cyber-resilience of inter-bank payment systems.
    - Give the oversight function adequate independence and resources to conduct thorough oversight of the Norwegian RTGS system (NBO).
  - Critical service providers:
    - Use existing legal powers to seek greater assurance and transparency from critical service providers, including performing or mandating regular cybersecurity audits and/or onsite inspection.

### E. AML/CFT — assessment and recommendations
- Progress since 2014 FATF evaluation:
  - Norway adopted a new AML Act and regulations in 2018, substantially strengthening its legal framework.
  - Higher ratings on 20 (out of 40) FATF recommendations in the recent reassessment; only five recommendations remain less than largely compliant.
  - 2019 FATF follow-up noted progress on effectiveness: improved understanding of ML/TF risks, development of a national AML/CFT strategy, improved national coordination and operational cooperation, and prioritization of vulnerabilities in high-risk areas including banking and payment institutions.
- Remaining weaknesses identified by FATF:
  - Overall level of effectiveness of AML/CFT oversight remained “moderate.”
  - Scope, intensity and frequency of FSA supervision remain insufficient and not always proportionate to identified levels of risk, particularly for banks (including foreign branches) and money transfer services.
  - The FSA had not used its powers to impose monetary penalties at the time of assessment; after the assessment the FSA imposed penalties on three banks for breaches of AML/CFT compliance.
- Recommendations to strengthen effectiveness:
  - Increase frequency of onsite AML/CFT inspections of banks, including branches of foreign banks, with targeted and thematic inspections.
  - Continue improving the risk-based approach to AML/CFT and supervisory tools and methodologies.
  - Pursue an active enforcement approach by applying monetary penalties as needed to address banks’ AML/CFT deficiencies.

### Systemic liquidity — key findings and vulnerabilities
- Assessment focus: functioning and resilience of key funding markets and authorities’ ability to manage liquidity conditions.
- Funding structure and vulnerabilities:
  - Given a limited deposit base, Norwegian banks rely on a diversified funding mix with a relatively large role for market-based funding.
  - High usage of market funding, related foreign currency exposures and cross holdings of covered bonds make banks vulnerable to changes in investor sentiment and market conditions domestically and abroad.
- FX swap and covered bond markets:
  - FX swap and covered bond markets are functioning well, with stable trading activity and resilience during past episodes of financial market turbulence and during the COVID-19 related volatility thus far.
  - Primary and secondary covered bond markets have a stable investor base mostly comprising institutions with long-term investment horizons (e.g., pension funds and insurance companies).
  - Caveat: Demonstrated past resilience does not preclude possible future liquidity problems; potentially high impact of funding and liquidity disruptions requires effective systems for liquidity management and support.

*Source: IMF staff*

### 61.      Norges Bank has an effective framework for managing liquidity in normal times.

### 61.      Norges Bank has an effective framework for managing liquidity in normal times.

### Effectiveness of liquidity operations in normal times
- Norges Bank carries out well-established operations that are generally effective in keeping banking system liquidity neutral in a context of often-large government transactions.
- The high correlation between the policy rate and the operational target (Norwegian Overnight Weighted Average rate, NOWA) confirms the effectiveness of the liquidity forecasting framework and the regular open market operations.
- The reported NOWA rate spikes at quarter-end, suggesting that banks are unwilling to lend at these times when they have to meet leverage ratio requirements (Figure 14).
- Recommendation: The authorities should consider whether the leverage ratio requirement could be averaged over each quarter to reduce incentives for this behavior.

### Framework for managing liquidity during stress
- Norges Bank can provide bilateral emergency liquidity assistance (ELA), including in foreign currency, to eligible financial institutions.
- Norges Bank has developed a framework to provide market-wide liquidity support, which can be carried out through longer term lending operations.
- The forceful response to liquidity pressures following the COVID-19 shock—which included extended lending operations in NOK and USD—confirms this assessment.

### Collateral availability and monitoring
- It would be useful to analyze and monitor more closely the availability of collateral across eligible counterparties.
- Monitoring information on the amounts of eligible collateral, including high-quality liquid assets, held by banks would allow Norges Bank to gauge the impact of liquidity regulation (for example relating to the LCR requirement) and assess in real time developments in, and risks to, the liquidity buffers of banks.

### Nonstandard collateral acceptance
- Completing ongoing work to facilitate acceptance of loan portfolios as nonstandard collateral would improve Norges Bank’s capacity to provide liquidity in times of stress.
- Such a framework would substantively broaden the universe of potentially acceptable collateral and improve Norges Bank’s capacity to provide both bilateral ELA and market-wide liquidity support.
- The preparation should involve relevant counterparties to develop and test the exchange of relevant loan and portfolio information in a timely and accurate manner.

### Benchmark interest rates
- The European Union Benchmark Regulation entered into force in Norway in December 2019 and the framework for the Norwegian interbank offered rate (NIBOR) was changed with effect of January 1, 2020.
- Further adjustments to the improved NIBOR should be made if and as needed to ensure smooth market functioning and market integrity.

### Financial safety nets and crisis management (key points linked to liquidity and resolution)
- Progress has been made with the resolution framework and crisis management arrangements, including adoption of the European Bank Recovery and Resolution Directive (BRRD) per January 2019.
- The FSA has been formally designated as the resolution authority and the resolution framework has been enhanced, including by the introduction of a bail-in tool framework for senior unsecured liabilities.
- Financing arrangements for bank resolutions were recently established by moving part of the funds accumulated in the deposit insurance fund—the Banks’ Guarantee Fund (BGF)—into a new resolution fund, with a separate fee structure.
- Key governance reforms at the BGF included reducing the number of active bankers in its board.
- A recent cross-border crisis-simulation within the Nordic-Baltic Stability Group revealed weaknesses in communication and coordination on ELA.

### Recommendations related to resolution and crisis-management architecture
- Give the FSA, as the resolution authority, clearly defined statutory resolution objectives and accountability; ensure the FSA can autonomously execute its resolution mandate without undue interference from the government or industry, limiting government involvement to resolutions that require public funds.
- Clarify responsibilities, accountabilities, procedures and information-sharing arrangements among relevant bodies, including stronger integration of the BGF with the resolution framework.
- Exclude any active bankers from the BGF Board.
- The BGF should not provide open bank assistance.
- Make the new resolution tools operational without delay, including establishing the mechanics of a bridge bank and asset separation tools and preparing modalities to finance the relevant operations.
- Make the resolution fund operational as soon as possible.
- Continue intra- and cross-institutional crisis simulation exercises to test the new tools.
- Prioritize the build-up of MREL, including the subordinated component.
- Work on the practical execution of the bail-in tool, given that the large majority of MREL (subordinated) instruments are likely to be held by foreign investors; consider applying multiple resolution options.
- Integrate existing court-based winding-up and liquidation procedures in the new administrative resolution framework.
- Consider taking a policy decision that the public interest test is met by default for most banks.
- Consider establishing an overarching system-wide crisis management framework with a high-level coordinating body mandated for system-wide contingency planning and coordination of policies and information sharing.
- Enhance cross-border crisis management arrangements within the Nordic-Baltic region; resolution colleges are important but should not substitute for high-level official crisis management preparedness.

*IMF staff summary based on content unit: 1norea2020001 - 61.      Norges Bank has an effective framework for managing liquidity in normal times.*

### 1. Prolonged COVID-

### 1. Prolonged COVID-19 outbreak and more protectionism.

### Major risks and transmission channels
- Extended containment measures and uncertainty about the intensity and duration of the COVID-19 outbreak:
  - Reduce supply (through disruption of global value chains) and domestic and external demand, resulting in a synchronized and prolonged growth slowdown globally.
- Deteriorating economic fundamentals and decline in risk appetite:
  - Could result in a second wave of financial tightening and in debt service and refinancing difficulties for corporates and households.
- Pandemic-prompted protectionist actions:
  - Actions such as export controls stay in place, while weaker economic conditions re-ignite broader protectionist measures.

### Expected near-term consequences (Medium / High)
- Reduced domestic consumption and external demand for exports together with weaker investment translate into:
  - Lower domestic growth and rising unemployment.
- Banking sector impacts:
  - Performance of banks’ loans to corporates and households weakens significantly.

---

### 2. Widespread and prolonged real estate market downturn

### Triggers and channels (Medium / High)
- Rising unemployment due to temporary or permanent layoffs weakens household balance sheets:
  - Leads to higher NPLs for banks and reduces bank risk appetite and availability of credit for real estate purchases or refinancing, reducing real estate market turnover.
- Structural changes:
  - Changes in work and shopping habits could affect commercial real estate (CRE).
- Funding shock:
  - Shutdown of global funding markets for covered bonds reduces credit available for purchase or refinancing of residential and commercial real estate, weakening prices.

### Macroeconomic and financial amplification (Medium)
- A substantial decline in residential and commercial real estate prices would:
  - Weaken private consumption.
  - Lower residential and commercial investment.
  - Lead to significant deterioration of banks’ balance sheets on both asset and liability sides.
- Feedback loop:
  - Falling house prices → higher non-performing loans → tighter bank credit → lower activity, amplifying the downturn.

---

### 3. Sharp rise in global risk premia

### Drivers (High)
- Sustained rise in risk premia linked to concerns about debt sustainability globally due to fiscal stimulus by sovereigns and reduction in corporate earnings relative to existing debt.
- Political or social instability from extended lockdowns contributes to higher global risk premia.

### Financial stability impacts (Medium)
- Banks face more difficult and expensive funding conditions.
- Banks’ asset quality weakens sharply due to relatively high direct lending exposure to corporates.
- Second-round effects: slower growth further degrades banks’ asset quality.

---

### 4. Oversupply in the oil market

### Drivers (High)
- Oil prices remain depressed for an extended period due to global demand contraction.
- Supply exceeds expectations because of failures of agreements between major suppliers to coordinate production cuts.
- The global transition to a low-carbon economy accelerates.

### Impacts (Medium)
- Sharp decline in energy prices reduces demand for oil-related mainland goods and services (as in 2014–16).
- Liquidity conditions tighten and lift the cost of capital.
- Falling profit margins of energy-related companies weaken debt-servicing ability and increase banks’ corporate NPLs.

---

### 5. Cyber-attack

### Nature and likelihood (Low)
- Cyber-security breaches and cyber-attacks engineered by state or non-state actors on a bank or critical payments infrastructure could disrupt financial intermediation and the flow of goods and services.

### Potential impacts (Medium)
- Significant disruptions of banks or payment systems dent confidence in the financial system.
- Individual institutions may suffer large losses and potentially fail.
- The cost of capital rises.

---

### Key macro-financial scenario variables (Table 7 highlights)
- Real GDP - Mainland (y/y percent change):
  - COVID Baseline: 2020 -5.5, 2021 3.8, 2022 3.3
  - COVID Downside: 2020 -7.1, 2021 2.6, 2022 0.6
  - Market Shock: 2020 -1.9, 2021 -3.3, 2022 0.5
- Unemployment rate:
  - COVID Baseline: 2020 8.2, 2021 6.6, 2022 4.5
  - COVID Downside: 2020 8.8, 2021 7.2, 2022 5.1
  - Market Shock: 2020 5.9, 2021 8.9, 2022 9.3
- Consumer price index (y/y percent change):
  - COVID Baseline & Downside: 2020 2.5, 2021 2.8, 2022 2.0
  - Market Shock: 2020 2.1, 2021 2.2, 2022 2.2
- Crude oil price:
  - COVID Baseline: 2020 36.2, 2021 37.5, 2022 40.8
  - COVID Downside: 2020 24.1, 2021 19.5, 2022 19.0
  - Market Shock: 2020 34.0, 2021 27.0, 2022 26.0
- Equity index (OSEAX):
  - COVID Baseline: 2020 -24.2, 2021 35.3, 2022 30.7
  - COVID Downside: 2020 -39.1, 2021 20.2, 2022 14.1
  - Market Shock: 2020 -33.0, 2021 -10.0, 2022 14.0
- House price index (y/y percent change):
  - COVID Baseline: 2020 0.8, 2021 7.5, 2022 7.1
  - COVID Downside: 2020 -1.8, 2021 7.2, 2022 6.0
  - Market Shock: 2020 -16.6, 2021 -11.9, 2022 -11.2
- 3-month money market rate (average):
  - COVID Baseline & Downside: 2020 1.0, 2021 0.3, 2022 0.3
  - Market Shock: 2020 2.2, 2021 2.6, 2022 2.9

---

### Key macroprudential measures related to the housing market (Table 8 highlights)
- Borrower-based requirements for mortgages (first introduced 2015):
  - Tolerate higher interest rate (stress test): 5 percentage points
  - Loan-to-value (LTV) ratio: 85 percent (60 percent for loans secured on secondary homes in Oslo)
  - Principal repayment requirement: 2.5 percent annually with LTV above 60 percent
  - DTI ratio (2017): 5 times gross income
  - Flexibility quota / “speed limit” (2015): 10 percent (8 percent or up to NOK 10m for loans secured on dwellings in Oslo). In March 2020, in the context of the COVID-19 outbreak, the flexibility quota was increased to 20 percent for all new loans
- Borrower-based requirements for consumer credit (2019):
  - Tolerate higher interest rate (stress test): 5 percentage points
  - Principal repayment requirement: Monthly principal repayment, maximum term 5 years
  - Debt-to-income (DTI) ratio: 5 times gross income
  - Flexibility quota / “speed limit”: 5 percent
- Banks’ weighted capital requirements (share of risk-weighted assets) (introduced 2013–2020):
  - Pillar 1 Minimum CET1 requirement (2013): 4.5 percent
  - Pillar 1 Minimum Tier 1 requirement (2013): 6 percent
  - Pillar 1 Minimum regulatory capital (2013): 8 percent
  - Pillar 1 Combined buffer requirements:
    - Capital conservation buffer (2013): 2.5 percent
    - Systemic risk buffer (2013): 3 percent
    - Buffer for systemically important financial institutions (SIFIs) (2015): 2 percent
    - Countercyclical capital buffer (2019; after COVID 2020): 2½ percent; 1 percent (after COVID)
  - Pillar 2 requirements (2016): Varies across banks
- Banks’ unweighted capital requirements (share of exposure measure):
  - Leverage ratio (2017): 3 percent minimum requirement + 2 percentage points buffer requirement + 1 percentage point buffer requirement for systemically important banks
- Liquidity requirements:
  - Liquidity Coverage Ratio (LCR) (2015): 100 percent
  - LCR in individual currencies (2017): 100 percent
  - LCR in NOK (2017): 50 percent (for banks with EUR/USD as significant currencies)
- Minimum requirement for own funds and eligible liabilities (MREL) and loss absorption amount (2019):
  - Minimum requirement for regulatory capital + Pillar 2 requirements + combined buffer requirements (MREL)
  - Amount necessary for recapitalization: Minimum requirement for regulatory capital + Pillar 2 requirements + combined buffer requirements excluding countercyclical capital buffer requirement

---

### Financial sector policy recommendations (Table 9 highlights)
- 2019:
  - It is too early to loosen macroprudential policy given remaining overvaluation and still rising household leverage.
  - Increase in the countercyclical buffer is appropriate in light of mounting risks from CRE valuations.
  - Full compliance with the recently improved AML/CFT legal framework will be paramount.
  - Mortgage regulations could be made permanent.
- 2018:
  - Make the temporary 2017 mortgage regulations a permanent part of the prudential toolkit and adjust parameters as the financial cycle requires.
  - Consider expanding regional differentiation of measures if house price overvaluation diverges further across regions.
  - Reduce generous tax preferences for housing and relax constraints on new property construction.
  - Authorities should stand ready to tighten prudential policies further, including Pillar II add-ons for CRE.
- 2017:
  - Authorities’ decisions include: increase in the CCB to 2 percent from December 31, 2017; new mortgage regulation effective 2017–mid-2018 introducing a DTI limit of five times gross annual income; leverage ratio requirement for banks of 5 percent (6 percent for the largest bank) from June 30, 2017.
  - Additional targeted measures suggested: tighter LTV limits, higher mortgage risk weights, deployment of macroprudential tools (such as a sectoral CCB to contain banks’ CRE exposures), reduce generous tax preferences for housing investment.
- 2016:
  - Consider additional targeted measures: higher mortgage risk weights; tighter LTV limits; supplement affordability test with loan-to-income (LTI) or debt-service-to-income (DSTI) ratio limits; tailor measures regionally.
  - Enhance stress tests to account for funding risks and monitor/limit banks’ wholesale funding, including mismatch between maturity of currency swaps and underlying exposures.
  - Strengthen legal and institutional framework for crisis management, safety nets, and bank resolution; finalize recovery plans, initiate resolution planning, and conduct resolvability assessments for the largest banks; strengthen regional cooperation on financial stability issues.

---

### Banking sector stress testing framework (Annex 1 key points)
- Institutional perimeter:
  - Bottom-up: 3 banks in scope account for 45 percent of the NO banking sector by assets (60 percent of total assets held by domestically incorporated banks): DNB Bank, SpareBank 1 SR-Bank, Sparebanken Vest.
  - FSA: 20 banking groups included in ST account for about 77 percent of Norwegian banks’ aggregate total assets at end-2018; additional analysis on sample identical to FSAP (11 banks).
  - NB: One “macro bank” comprising nine large banks (about 60 percent of NO banking market by assets) including DNB Bank and eight others.
  - FSAP ST comprises 11 largest domestic banks which hold approximately 60.5 percent of domestic banking sector assets. ST does not include branches of foreign banks operating in Norway.
- Data source / baseline date:
  - Internal audited data (where available) and other internal data. Baseline date: June 30, 2019.
  - CRD IV reporting and other supervisory and public data sources. Baseline date: June 30, 2019.
  - Supervisory and publicly available data. Baseline date: June 30, 2019.
- Approach and models:
  - Balance sheet-based approach used across bottom-up and top-down exercises.
  - FSA: Proprietary macro model for total loan losses and satellite-proxy PD model for distribution of loan losses on loans to NFC; satellite model for market risk.
  - NB: Satellite models for loan losses; banks’ loan losses in the stress scenario follow “rule of thumb” as a function of GDP developments.
  - FSAP team: Satellite models for PDs, LGDs, and NPL ratios; market losses based on modified duration and shocks to rates as assumed under scenarios.
- Horizon:
  - 3 years (2020–2022).
- Scenario design and tail shocks:
  - COVID central scenario based on a preliminary version of the June 2020 WEO projections.
  - Market Shock Scenario simulated using IMF’s Flexible System of Global Models for global variables and Norges Bank’s NEMO model for Norwegian variables.
  - COVID scenarios: variable paths obtained as conditional forecasts in a Vector AutoRegression conditional on the June 2020 WEO projections for GDP, unemployment and inflation, plus the WEO forecast for the oil price; some variables calibrated judgmentally.
  - Under Market Shock annual GDP growth: -1.94 percent (2020), -3.27 percent (2021), +0.51 percent (2022). Cumulative house price decline reaches -35 percent over the risk horizon under Market Shock; under COVID central and COVID downside house prices record cumulative growth of 16.2 and 11.6 percent, respectively.
  - NOK depreciates by 8.7 percent in the first year, leading to a cumulative appreciation / depreciation of 10.7 percent at the end of the third year in all scenarios.
- Behavioral adjustments and constraints:
  - Passive balance sheet assumption: static balance sheets apart from credit growth linked to nominal GDP growth; balance sheet composition constant; no asset disposals/acquisitions except in line with aggregate credit growth.
  - Capital increases not permitted unless approved prior to cut-off date.
  - Defaulted exposures do not generate interest income after impairment.
  - Dividend payout assumptions vary: banks assumed to make dividend payouts of 50 percent for periods with positive net income and no payouts in case of negative net income in some exercises; NB assumed no dividend payouts in the whole stress period.
- Sensitivity analyses:
  - Conducted to evaluate single risk factors: FX shock; Interest Rate Risk in the Banking Book (IRRBB); Credit concentration risk; climate change transition risks.
- Reporting and output presentation:
  - System-wide capital shortfall reported; number of banks and percentage of banking system assets falling below capital hurdles reported.
  - Impact of different result drivers, including profit components and losses due to realization of different risk factors, presented.

*Source: IMF staff (Norway Financial Sector Assessment excerpts).*

### Annex 1. Banking Sector Stress Testing Matrix (STeM) (Cont.)

### Annex 1. Banking Sector Stress Testing Matrix (STeM) (Cont.)

### Banking Sector: Liquidity Risk — Institutional perimeter and coverage
- Stress test can be run on all Norwegian banks (unconsolidated). The model also includes links between banks and covered bond companies.
- FSA and Norges Bank are collaborating on developing a liquidity stress testing framework for Norwegian banks and mortgage companies.
- ST comprises 11 largest domestic banks which hold approximately 60.5 percent of domestic banking sector assets.
- Based on data availability, foreign branches could partially be involved into the exercise.
- Baseline date: June 30, 2019.

### Banking Sector: Liquidity Risk — Data, methodology, and channels of risk
- Data sources:
  - CRD IV— LCR and NSFR.
  - Non-CRD IV reporting—Balance sheet data, "Refinancing under stress."
  - Supervisory and publicly available data.
- Methodology:
  - Cash flow analysis of inflows and outflows from assets, liabilities and off-balance sheet items.
  - Cash-flow based liquidity stress test using maturity buckets.
  - Basel III LCR and NSFRs.
  - Separate analysis for NOK, EUR and USD.

### Banking Sector: Liquidity Risk — Risks, buffers, and tail shocks
- Risks tested:
  - Bank-specific stress, such as bank ratings downgrade.
  - Domestic/global market stress triggering house price decline and NOK depreciation.
  - Shock to funding (stressed outflow and inflow factors) and available liquidity (haircuts).
  - Bank run and dry up of wholesale funding markets, taking into account haircuts to liquid assets.
- Buffers considered:
  - Banks’ liquidity reserves with haircuts.
  - LCR buffer.
  - Extended liquidity reserve (includes non-LCR available securities and bank deposits).
  - Possible new issuances of covered bonds (where loans are readily available for transfer to the CB company and/or there are free cover pool assets within the CB company).
  - Available and unencumbered liquid assets.
- Tail shocks and sizing:
  - Projections are based on the expected behavior of banks, customers and depositors as well as other banks and market actors.
  - Run-off rates calculated following historical events and based on IMF methodology (for cash flow analysis).
  - The stress factors are generally applied for a 30-day period. The model assumes declining stress. The same stress factors are applied for the next period (day 30 to 90) and reduced to zero after three months.

### Banking Sector: Liquidity Risk — Regulatory standards and reporting
- Regulatory standards:
  - National regulatory framework.
  - LCR: 100 percent, consistent with Basel III LCR framework.
  - NOK LCR: 50 percent (only applies to seven largest banks).
- Output presentation and reporting format:
  - Survival horizon – time from initial event to net liquidity < 0.
  - Net liquidity equals the difference between financing gap and the bank’s liquidity reserves.
  - System-wide liquidity gaps.

### Banking Sector: Interconnectedness — Institutional perimeter and data
- Institutions included:
  - 20 institutions for which there is data coverage (including 11 largest).
  - Largest 11 banks which hold approximately 60.5 percent of the domestic banking sector assets.
- Data source and baseline date:
  - Source: Supervisory data.
  - Baseline date: June 30, 2019.

### Banking Sector: Interconnectedness — Methodologies and channels of risk propagation
- Methodologies used:
  - Combined direct and indirect contagion model based on Cont and Schaaning (2017) and Hueser et al. (2017).
  - Balance sheet-based interbank model by Espinosa-Vega and Solé (2010).
  - Market price-based spillover model by Diebold and Yilmaz (2014).
  - Cross-border network model by Espinosa-Vega and Solé (2010).

### Banking Sector: Interconnectedness — Risks, buffers, tail shocks, and reporting
- Risks:
  - Risk of indirect contagion due to price impact from fire sales of cross holdings, risk of direct contagion due to potential bail-in of MREL cross-holdings.
  - Credit and funding losses related to interbank cross-exposures (and cross-border banking exposures).
- Buffers:
  - Banks’ own capital buffers.
  - Banks’ own capital and liquidity buffers.
- Tail shocks:
  - Initial shock results from top-down stress test and may trigger funding difficulties.
  - Pure contagion: Assumed failure of institutions.
- Output presentation and reporting format:
  - Contagion analysis: additional amplification (pp of CET1 ratio) of shock from solvency stress test.
  - Network analyses with supervisory data.
  - System-wide capital shortfall.
  - Number of undercapitalized and failed institutions, and their shares of assets in the system.
  - Evolution and direction of spillovers.

### Authorities' response and key policy positions (Statement by Mr. Pösö and Mr. Evjen)
- General assessment:
  - The Norwegian authorities thank staff for the Financial System Stability Assessment (FSSA) report and value the analyses and policy recommendations.
  - Although the coronavirus has changed the outlook significantly, most recommendations will still be valid after the pandemic subsides.
  - The report concludes that Norway has taken welcome steps to strengthen the financial system since the last FSAP, while several vulnerabilities and challenges remain.
- Macroprudential policy:
  - Norway has used the macroprudential toolkit actively in recent years.
  - Effective use requires close coordination and cooperation between Finanstilsynet, Norges Bank, and the Ministry of Finance.
  - Triparty meetings (established nearly 15 years ago) are a key forum; authorities note recommendations to use them more effectively but emphasize any changes must respect individual authorities’ roles and responsibilities.
  - On publishing a macroprudential strategy, authorities agree more transparency could improve accountability and effectiveness but caution there are limits to ex ante transparency (for example regarding ex ante signals on how LCR requirements will be managed in periods of liquidity stress).
- Banking regulation and supervision:
  - Authorities note recommendations on giving Finanstilsynet more independence in regulatory powers, operations, and budget; continuous assessment of power delegation is emphasized.
  - Finanstilsynet has proposed appointing a law committee to review the Financial Supervision Act; this proposal is under consideration by the Ministry of Finance.
  - On inspections and AML/CFT oversight: recommendations to increase inspections in smaller banks and strengthen AML/CFT oversight are noted; annual budget proposals reflect trade-offs across supervisory needs and other tasks.
  - Since June 2019, Finanstilsynet has been sanctioning non-compliance with the law to signal that non-compliance will not be tolerated.
  - The Norwegian government has recently published a new strategy for AML/CFT.
- Crisis management and resolution:
  - Authorities agree Finanstilsynet should be able to execute its mandate autonomously and that there should be clear lines of responsibility, but stress the importance of democratic legitimacy for resolution decisions and the benefits of historical cooperative arrangements between Finanstilsynet and the Ministry.
  - Authorities note the FSSA’s proposal to establish a high-level coordinating body for contingency planning and crisis prevention and management, but caution a new body could blur division of responsibilities and delay crisis response; will continue to seek improvements in legislation, institutional setup, and framework.
- Cybersecurity supervision:
  - Authorities welcome analysis and recommendations on cybersecurity risk supervision and oversight, including improving incidence reporting and crisis management frameworks for systemic cyber incidents.
  - Note that Norway already has well-established requirements and processes for reporting of ICT incidents, including cybersecurity incidents, which promotes timely sharing of information.

### Other issues and COVID-19 impact
- Current macro-financial conditions (as of statement):
  - Due to the Covid-19 pandemic and containment measures, the Norwegian economy is in a severe downturn, although mitigated by extensive measures introduced by the authorities.
  - Government measures are supporting both the supply of and demand for credit.
  - Credit growth has fallen, and credit losses have increased and are likely to stay at elevated levels the coming quarters.
  - Financial market volatility has been reduced, risk premiums on banks’ wholesale funding have fallen, and both turnover and prices in the housing market rebounded significantly after a sharp fall in March.
- Stress testing and policy importance:
  - The supplementary Covid-19 stress test illustrates possible consequences going forward.
  - Stress tests are valuable tools to illustrate the banks' sensitivities to different outcomes.
  - Authorities emphasize significant uncertainty going forward and the importance that policy decisions and regulatory actions contribute to the soundness of financial undertakings, households, and firms.

*Source: Annex 1. Banking Sector Stress Testing Matrix (STeM) (Cont.), provided content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1norea2020001.pdf_