## 1norea2020006 ## Source details **Canonical URL:** [1norea2020006](https://www.imf.org/-/media/files/publications/cr/2020/english/1norea2020006.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1norea2020006.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1norea2020006.pdf.json) --- ### Overview - Norwegian banks and other financial institutions rely heavily on capital markets for liquidity and risk management. - Nearly 40 percent of the funding of Norwegian banks is obtained from market sources, using commercial paper, covered bonds, and senior unsecured bonds issued both domestically and abroad. - Money markets, FX swap markets and bond markets are crucial to the credit intermediation process; a dislocation in these markets—the inability of financial institutions to roll over, or obtain new, funding—could have significant consequences for financial stability. - The note analyzes core funding markets for Norwegian banks and assesses Norges Bank’s capacity to manage systemic liquidity conditions and counteract liquidity shocks in normal times and in times of stress. ### Money markets and FX swap markets - FX swaps: - FX swaps are the most important money market instruments in Norway; large banks use FX swaps both for liquidity management and hedging purposes. - FX swap maturities range between overnight (predominantly liquidity management) and longer maturities up to 91 days (mainly hedging). - FX swaps account for more than 90 percent of all FX transactions; other instruments play much smaller roles: - spot transactions: five percent - outright forwards: two percent - cross currency basis swaps: one percent - currency options: less than one percent - FX turnover in NOK is small compared to a wide range of developed market currencies; NOK is the eighth most actively traded currency worldwide, measured by turnover-to-gross domestic product (GDP). The majority of FX transactions in NOK are carried out abroad. - FX swap trades are initiated bilaterally and settled centrally via LCH Clearnet or CLS Bank (FX swaps, cross currency swaps, FX spot transactions). - Participants: - Nordic banks swap foreign currency funding for Norwegian kroner (NOK) to fund Norwegian assets. - Pension funds and other asset managers swap NOK for foreign currency to hedge investments in foreign currencies. - Foreign banks and hedge funds act as market makers and use the FX swap market to take positions on interest rates and the exchange rate. - Market resilience: - FX swap markets function well and are resilient in stress; central clearing via LCH Clearnet reduces counterparty risk. - Short-term (overnight) FX swaps are liquid and resilient with high turnover and many active counterparties (domestically and in London, New York). - FX spot market is less resilient; liquidity is perceived to be rather low and activity concentrated among a small number of counterparties. - Cross-currency basis swap market is small with lower turnover and fewer counterparties; turnover in the small segment of cross currency swaps has increased. ### Unsecured overnight, repo markets, and short-term instruments - Unsecured overnight market: - Active but less important; domestic large banks trade central bank reserves overnight to manage swings in structural liquidity and to manage excess liquidity or shortfalls. - NOWA spreads usually very small, on average less than 1 basis point; on quarter- and year-ends NOWA can spike due to low turnover. - Repo market: - Repo transactions account for a relatively small but growing share of market turnover and tend to have maturities mostly 8−31 days. - Most repurchase agreements use Norwegian Treasury bills, government bonds, and covered bonds as collateral and are OTC trades. - Repo activity has increased, with large banks and savings banks as net cash borrowers and asset managers or hedge funds lending securities. - Short-term instruments and Treasury bills (amounts outstanding, June 2019, in billions of Norwegian Kroner): - Treasury bills: 70.3 (Government of Norway; ≤12 months) - Commercial paper issued by local governments: 51.9 (≤12 months) - Commercial paper issued by nonfinancial corporations: 17.8 domestic, 7.2 foreign (≤12 months) - Commercial paper issued by financial institutions: 1.9 domestic, 135.9 foreign (≤12 months) - T-bills: - Issued by Norges Bank on behalf of the Ministry of Finance with maturities up to one year and listed on Oslo Børs (OSE). - Held mainly by the government, insurance companies and pension funds; domestic banks hold a comparatively low share of currently 16 percent. - Use of T-bills as collateral in repo transactions is limited; secondary market liquidity (measured by turnover ratio) is overall stable though showing a slightly declining trend. ### Benchmarks, market infrastructure, and governance - Key benchmarks: - NOWA (Norwegian Overnight Weighted Average rate) — NOWA is the interest rate on unsecured overnight interbank lending in NOK; administered by Norges Bank as of January 1, 2020; calculated usually based on actual trades; NOWA panel comprises 11 panel banks. - Nibor (Norwegian Interbank Offered Rate) — administered by Norske Finansielle Referanser AS (NoRe); intended to reflect lending rate for unsecured money market lending in NOK; quoted at maturities of one week, and one, two, three and six months; three- and six-month Nibor are widely used. - Benchmark reforms and governance: - Nibor is in practice not transaction-based; 6 panel banks effectively base their submissions on estimates (expert judgement). - NoRe has applied for authorization under the BMR which entered into force in Norway on 20 December 2020. The European Commission has initially classified Nibor as “uncritical” for an interim period. - Nibor new calculation methodology introduces a waterfall approach: Level A (interbank lending rates), Level B (prices from sales of CDs), Level C (expert judgements; committed quotes on CDs to be given at least 50 percent weight compared to expert judgments). - Norges Bank established a working group on alternative reference rates in NOK; a reformed NOWA regime (transaction-based) implemented with Norges Bank as administrator from January 1, 2020. On days with very low liquidity, calculation will be based on a combination of historical data and actual traded data. - Both administrators aim to adhere to IOSCO principles; subject to inclusion in the EEA agreement foreseen for end-2019, EU Benchmark Regulation (BMR) applies. ### Sovereign, bond markets, covered bonds, and banks’ funding mix - Sovereign bond market: - Outstanding government debt securities account for NOK 387 billion, representing only 18.2 percent of GDP. - Government borrowing is used to finance loans made by state lending institutions and does not finance the national budget deficit. - Secondary market liquidity is considered to be low relative to other Nordic or European government markets; most trades are bilateral and electronic platforms complicate monitoring. - Norwegian government bonds are held predominantly by foreign investors; domestic banks and mortgage companies hold below 20 percent. - Bond market outstanding amounts (June 2019, in billions of NOK): - Central government bonds: 386.8 (Government of Norway; ≤ 10 years) - Local government bonds: 110.0 - Covered bonds: 587.5 714.0 (Mortgage companies; Issued abroad: ≤ 11 years; Domestic: ≤ 6 years) - Financial institution senior unsecured bonds: 343.2 306.0 (Large banks; ≤ 5 years) - Corporate bonds: 216.2 34.0 (Large corporates; ≤ 10 years) - Foreign issuer bonds: 316.6 (International organizations; ≤ 10 years) - Public non-financial corporations: 114.3 310.1 (≤ 15 years) - Covered bonds and funding mix: - The banking sector is the largest issuer; market-based funding represents 50 percent of banks’ liabilities. - Covered bonds represent approximately 50 percent of market-based funding; senior unsecured bonds account for a stable share of 20 percent. - Short-term wholesale and interbank funding now account for approximately 30 percent of total market-based funding, down since 2007. - Covered bond market aggregate outstanding: 1,258 billion NOK; share of GDP: 32 percent of GDP. - Covered bond issuance by currency and place: - 46 percent of covered bonds outstanding were issued in NOK, 54 percent were issued in foreign currencies. - Foreign currency composition: euro 48 percent, U.S. dollar 4 percent, other currencies 3 percent. - 24 active issuers; largest issuers: DNB Boligkreditt 37 percent; SpareBank 1 Boligkreditt 19 percent; Eika Boligkreditt 7 percent; Nordea Eiendomskreditt 7 percent. - Most covered bonds backed by residential mortgages; commercial mortgage-backed covered bonds are <3 percent of outstanding volume. - Domestic covered bonds: usually variable rate coupon and maturities up to 5 years; issued abroad: usually fixed rate coupon and maturities up to 10 years. ### Systemic liquidity risks and funding vulnerabilities - Key vulnerabilities: - Banks’ high reliance on market funding, concentrated securities holdings, and common risk exposures through underlying lending portfolios create systemic liquidity concerns. - Reliance on market funding exposes banks to investor sentiment and market conditions; cross holdings of covered bonds compound risks. - Reliance on foreign investors diversifies but increases vulnerability to global market sentiment. - Some large Norwegian banks rely heavily on both short- and long-term market-based funding in foreign exchange and essentially manage liquidity on a U.S. dollar basis. - There are virtually no bank CPs and CDs in NOK; large banks issue CPs and CDs abroad in U.S. dollar and other currencies. - Interaction with liquidity regulation: - LCR requirements shape HQLA portfolios; international issuers with zero risk weight, government bonds and covered bonds dominate HQLA holdings. - LCR-total minimum: 100 percent (applicable since December 31, 2015 with a step-up plan earlier); LCR-NOK minimum: 50 percent for institutions with EUR or USD as significant currency (in force since September 30, 2017); LCR in other significant currencies: 100 percent (since September 30, 2017; non-SIFIs had 80 percent transitional requirement). - NSFR: reporting requirement with no minimum applied; NSFR levels slightly increasing since 2014. - NOK LCR requirement may contribute to heightened volatility in Nibor rates at quarter and year end. - Sectoral notes: - Mutual fund sector assets under management: NOK 1.129 billion, representing 32 percent of GDP; equity funds 53 percent, bond funds 27 percent, money market funds 9 percent. - Large banks may be close to the 50 percent LCR-NOK limit; large outflows to the government account at Norges Bank may trigger structural liquidity shocks. ### Norges Bank’s liquidity management, operational framework, and market operations - Operational framework: - Norges Bank’s framework for standard liquidity management operations is well-established and effective; liquidity forecasting and a regular schedule of open market operations provide effective transmission of policy signals; high correlation of policy rate and NOWA. - Correlation between policy rate (sight deposit rate) and NOWA is overall high; spikes in NOWA at quarter or year-end reduce correlation. - Quota system: - Introduced in 2011; restricts level of banks’ reserves remunerated at key policy rate; additional reserves remunerated at reserve rate (1 percent below sight deposit rate). - Quotas assigned to eligible counterparties and updated twice a year based on total assets. - Bank grouping by total assets: - Group 1: DNB Bank ASA, NORDEA, Danske Bank, Handelsbanken, SEB (Oslofilialen) and Swedbank Norge. - Group 2: 15 mid-size banks. - Group 3: remaining smaller 105 banks. - The sum of all quotas (of currently NOK 45 billion) is slightly above the targeted level of reserves (of NOK 35 billion, +- 5 billion). - Operational tools and amendments: - Steering reserves via F-loans and F-deposits; standing facilities: overnight D-loans and deposits at the reserve rate. - Fine-tuning operations late in the day when reserves deviate from desired level. - Amendments to mitigate quarter- and year-end stresses: - Additional F-loans at last trading date of each quarter at fixed rate, full allotment, maturity three month, priced at key policy rate +15 basis points. - Selected F-loan auctions to be settled T+2 on days with strong declines in structural liquidity. - Change to floating interest rate for market operations spanning monetary policy meetings. - Forecasting and structural liquidity: - Structural liquidity is volatile and influenced by government transactions; Norges Bank conducts both liquidity providing and absorbing operations to sterilize government transactions. - Liquidity forecasting relies on informal information exchange with the Ministries; Norges Bank publishes forecast for structural liquidity two times a week. - Collateral and counterparty frameworks: - Broad counterparty eligibility: commercial banks and savings banks headquartered in Norway; branches in Norway of banks/credit institutions headquartered elsewhere; EEA cross-border providers; limited case-by-case access for non-EEA institutions. - Broad collateral framework includes bonds, notes and short-term papers, units of bonds and money market funds, fixed deposits in Norges Bank, and deposits in other central banks. - Guidelines specify haircuts, eligibility, valuation; around 30 percent of mobilized eligible securities have a theoretically determined price; pricing based on nominal amount applied rarely (~2 percent). - Monitoring published on recourse to Norges Bank credit and amounts of collateral mobilized; more detailed information on asset-class use and overall universe of eligible collateral appears incomplete. ### Emergency Liquidity Assistance (ELA), foreign currency operations, reserves, and cooperation - Legal basis and eligibility: - The Norges Bank Act of 1985 provides legal basis for LOLR and liquidity support in domestic and foreign currency. - ELA provided only to domestic financial institutions and subsidiaries of foreign institutions; branches of foreign banks are explicitly not eligible. Banks in resolution may be considered eligible. - ELA procedures and preparedness: - Norges Bank has published guidelines for applying for ELA specifying required financial and liquidity information. - Internal framework outlines roles, responsibilities and procedures; Norges Bank informs the FSA and MoF on ELA requests; Executive Board or Governor decides on granting ELA. - Preparatory work underway to assess, value and mobilize mortgage loan portfolios as collateral; recent amendments to the Financial Collateral Act allow acceptance of mortgage loan portfolios. - Operational preparedness could be improved through testing and inter-agency arrangements with MoF and FSA, including tests with D-SIBs and mid-sized banks, and simulations of mobilizing non-standard collateral. - Foreign currency operations, reserves, and limits: - Foreign exchange swaps and foreign currency loans form part of Norges Bank’s operational framework and can be activated in stress. - During 2008−09, foreign exchange swaps provided: US$26.9 billion; euro EUR 9.9 billion. Collateralized foreign currency loans provided during 2008–09: US$27.0 billion. - Provision of foreign currency funding is contingent on access to foreign-currency funding, FX reserves and swap lines. - Aggregate market value of foreign exchange reserves currently NOK 517.3 billion (13.7 percent of GDP). - Fixed income portfolio: 80 percent of portfolio; invested in cash deposits and Treasury bills and sovereign bonds of France, Germany, Japan, U.K. and U.S. - Half of fixed income portfolio in U.S. dollar; 34 percent in euro; British pound and Japanese yen each represent 8 percent of this portfolio. - Equity portfolio contains liquid equities listed on regulated exchanges. - Norges Bank entered into a bilateral currency swap agreement with the U.S. Federal Reserve in September 2008; this arrangement is currently inactive and no other swap arrangements exist. - International cooperation: - Norges Bank should continue international cooperation with other central banks to ensure swift coordinated action in a severe financial crisis. ### Market functioning, supervisory priorities, and regulatory interactions - Market functioning: - Government bond market is small and has limited capacity as a safe haven; small market size impacts secondary market liquidity and benchmark curve completeness. - Covered bonds are perceived overall to be more liquid than government bonds. - Growing covered bond issuance in the euro area increases susceptibility to shocks in demand. - Supervisory priorities and regulatory interactions: - Monitor HQLA portfolio composition closely (by Norges Bank and FSA). - Monitor interaction between money market functioning and liquidity regulation, including domestic currency LCR requirement (currently at 50 percent). - Attention to banks’ reliance on market funding and covered bond concentration and cross holdings. - Regulatory developments (BRRD, EU securitization regulation) may change the universe of financial instruments; uncertain whether senior nonpreferred bonds will substitute senior unsecured bank bonds. ### FSAP key recommendations and supervisory actions (selected) - Assess and monitor more closely the availability of collateral across eligible counterparties. (Norges Bank; ¶78) — Timing: I (Immediate: within 1 year) - Assess whether changing the basis for calculating the leverage ratio (averaging) and other measures may increase money market activity at quarter and year end. (FSA; ¶77, 78) — Timing: ST (Short term: 1–2 years) - Continue ongoing efforts to complete the transition towards a Nibor benchmark in line with the BMR to ensure market integrity. (FSA; ¶72) — Timing: I - Continue work to test a framework for the acceptance of mortgage loan portfolios as emergency liquidity assistance (ELA) collateral. (Norges Bank; ¶83 and 84) — Timing: ST - Clarify further relevant roles and responsibilities regarding liquidity support to critical securities markets and improve inter-agency arrangements with the MoF and the FSA. (Norges Bank; ¶82) — Timing: I - Continue international cooperation with other central banks to ensure that steps can be taken quickly to provide liquidity support in foreign currencies in case of a severe financial crisis. (Norges Bank; ¶86) — Timing: ST *Source: 1norea2020006 (IMF).* ### EXECUTIVE SUMMARY ____________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### Overview - Norwegian banks and other financial institutions rely heavily on capital markets for liquidity and risk management. - Liquidity conditions in the Norwegian financial sector are affected by central bank operations and the lending and funding activities of financial institutions, both domestically and abroad. - Nearly 40 percent of the funding of Norwegian banks is obtained from market sources, using commercial paper, covered bonds, and senior unsecured bonds issued both domestically and abroad. - Money markets, foreign exchange (FX) swap markets and bond markets are crucial to the credit intermediation process; a dislocation in these markets—the inability of financial institutions to roll over, or obtain new, funding—could have significant consequences for financial stability. - The note analyzes core funding markets for Norwegian banks and assesses Norges Bank’s capacity to manage systemic liquidity conditions and counteract liquidity shocks in normal times and in times of stress. ### Money Markets and FX Swap Markets - FX swaps are the most important money market instruments in Norway; large banks use FX swaps both for liquidity management and hedging purposes. - FX swap maturities range between overnight (predominantly liquidity management) and longer maturities up to 91 days (mainly hedging). - FX swaps account for more than 90 percent of all FX transactions; other instruments play much smaller roles: - spot transactions: five percent - outright forwards: two percent - cross currency basis swaps: one percent - currency options: less than one percent - Key market participants: - Nordic banks swap foreign currency funding for Norwegian kroner (NOK) to fund Norwegian assets. - Pension funds and other asset managers swap NOK for foreign currency to hedge investments in foreign currencies. - Foreign banks and hedge funds act as market makers and use the FX swap market to take positions on interest rates and the exchange rate. - FX swap trades are initiated bilaterally and settled centrally via LCH Clearnet or CLS Bank (FX swaps, cross currency swaps, FX spot transactions). - FX turnover in NOK is small compared to a wide range of developed market currencies; NOK is the eighth most actively traded currency worldwide, measured by turnover-to-gross domestic product (GDP). The majority of FX transactions in NOK are carried out abroad. - The Norwegian FX spot market is small compared to the FX swap market; key players are foreign banks and large Nordic banks. Liquidity in the spot market is perceived to be rather low. ### Unsecured Overnight and Repo Markets - The unsecured overnight market is active but less important; domestic large banks trade central bank reserves overnight to manage swings in structural liquidity and to manage excess liquidity or shortfalls. - Repo transactions account for a relatively small but growing share of market turnover and tend to have maturities mostly 8−31 days. - Most repurchase agreements use Norwegian Treasury bills, government bonds, and covered bonds as collateral and are over the counter (OTC) trades. - Repo activity has increased, particularly with large banks and savings banks as net cash borrowers and asset managers or hedge funds lending securities (e.g., covered bonds) to increase leverage and duration. ### Short-term Instruments and Treasury Bills - Table 2 (Money Market Instruments, June 2019) shows amounts outstanding (in billions of Norwegian Kroner) for: - Treasury bills: 70.3 (Government of Norway; ≤12 months) - Commercial paper issued by local governments: 51.9 (≤12 months) - Commercial paper issued by nonfinancial corporations: 17.8 domestic, 7.2 foreign (≤12 months) - Commercial paper issued by financial institutions: 1.9 domestic, 135.9 foreign (≤12 months) - Treasury bills (T-bills) are the most important domestic short-term debt instrument; issued by Norges Bank on behalf of the Ministry of Finance with maturities up to one year and listed on the Oslo stock exchange (OSE). - T-bills are held mainly by the government, insurance companies and pension funds; domestic banks hold a comparatively low share of currently 16 percent. - Use of T-bills as collateral in repo transactions is limited; secondary market liquidity (measured by turnover ratio) is reportedly overall stable though showing a slightly declining trend. ### Benchmarks and Market Infrastructure - Two key benchmark interest rates referenced in many financial contracts including derivatives are: - Norwegian Overnight Weighted Average rate (NOWA) - Norwegian interbank offered rate (Nibor) - Benchmark administrators—Norges Bank and Norske Finansielle Referanser AS (NoRe)—have undertaken efforts to improve accuracy and integrity to adhere to global standards. - The European Union Benchmark Regulation entered into force in Norway in December 2019 and the framework for 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. ### Bond Markets and Covered Bonds - Domestic money and fixed income securities markets are relatively small because banks rely heavily on foreign markets for funding and the government does not have a large borrowing need. - Given a limited supply of government securities, the Norwegian bond market is dominated by issuance from banks. - Bond market participants that need safe-haven assets tend to use covered bonds. - Banking groups that issue covered bonds (via mortgage companies) have partially substituted other sources of wholesale funding, such as senior unsecured funding and short-term wholesale funding, with this longer-term instrument. - Systemic vulnerabilities could arise because covered bonds are backed by mortgage loans; shocks in the housing market could impair functioning and liquidity of the covered bond market. ### Systemic Liquidity Risks and Funding Vulnerabilities - Systemic liquidity concerns relate to: - Banks’ high reliance on market funding, - Concentrated securities holdings, - Common risk exposures through underlying lending portfolios. - Reliance on market funding exposes banks to investor sentiment and market conditions, with risks potentially compounded by banks’ cross holdings of covered bonds. - Banks’ reliance on foreign investors contributes to diversification but makes issuers vulnerable to global market sentiment. - Some large Norwegian banks rely heavily on both short- and long-term market-based funding in foreign exchange, benefitting from currently favorable market conditions (low interest rates in FX borrowing). These large banks essentially manage their liquidity on a U.S. dollar basis. - There are virtually no bank commercial paper (CPs) and certificates of deposit (CDs) in NOK; large banks issue CPs and CDs abroad in U.S. dollar and other currencies. Large Nordic banks’ access to foreign short-term funding markets in particular in the United States (U.S.) provides a competitive advantage and reduces overall funding costs. ### Norges Bank’s Liquidity Management and Operational Framework - Norges Bank’s framework for conducting standard liquidity management operations is well-established and effective. - A robust liquidity forecasting framework and a regular schedule of open market operations provide an effective operational framework for the transmission of policy signals, evidenced by the high correlation of the policy rate and the operational target (NOWA rate). - Market frictions and spikes in NOWA occur around quarter and year end; these appear driven by capital and leverage ratio requirements and an apparent unwillingness of banks to lend at quarter and year end. - Recommendation: Norges Bank and the FSA should consider whether it is possible to average out these requirements over each quarter. - Expanding efforts to analyze the availability of collateral across eligible counterparties would be beneficial to inform Norges Bank on: - its risk taking, - the impact on secondary market liquidity, - the level of unencumbered assets, - interaction with liquidity regulation, i.e., liquidity coverage ratio (LCR) requirements and availability and use of high-quality liquid assets (HQLA). ### Operational Preparedness and Emergency Liquidity - Operational preparedness for support of key securities markets could be improved through a framework for intervention. - Norges Bank should lead preparatory work to improve inter-agency arrangements with the Ministry of Finance (MoF) and the FSA to support and ensure smooth functioning of critical securities markets, including for covered bonds. - Norges Bank should continue work to test a framework for the acceptance of mortgage loan portfolios as collateral in an emergency liquidity situation. - Acceptance of mortgage loan portfolios would broaden the universe of potentially acceptable collateral and improve Norges Bank’s capacity to provide bilateral Emergency Liquidity Assistance (ELA) or market-wide liquidity support. - Preparation should involve relevant counterparties to develop and test the exchange of relevant loan and portfolio information in a timely and accurate manner. - Continue international cooperation with other central banks to ensure that steps can be taken quickly to provide liquidity support in foreign currencies in case of a severe financial crisis. ### FSAP Key Recommendations (selected) - Assess and monitor more closely the availability of collateral across eligible counterparties. (Norges Bank; ¶78) — Timing: I (Immediate: within 1 year) - Assess whether changing the basis for calculating the leverage ratio (averaging) and other measures may increase money market activity at quarter and year end. (FSA; ¶77, 78) — Timing: ST (Short term: 1–2 years) - Continue ongoing efforts to complete the transition towards a Nibor benchmark in line with the BMR to ensure market integrity. (FSA; ¶72) — Timing: I - Continue work to test a framework for the acceptance of mortgage loan portfolios as emergency liquidity assistance (ELA) collateral. (Norges Bank; ¶83 and 84) — Timing: ST - Clarify further relevant roles and responsibilities regarding liquidity support to critical securities markets and improve inter-agency arrangements with the MoF and the FSA. (Norges Bank; ¶82) — Timing: I - Continue international cooperation with other central banks to ensure that steps can be taken quickly to provide liquidity support in foreign currencies in case of a severe financial crisis. (Norges Bank; ¶86) — Timing: ST *Source: EXECUTIVE SUMMARY, Norway Financial Sector Assessment (IMF).* ### 11. The turnover in the small market segment of cross currency swaps has increased ### 11. The turnover in the small market segment of cross currency swaps has increased ### Cross currency swaps and mortgage companies - Cross currency swaps form an integral part of mortgage companies’ hedging strategies. - Mortgage companies that issue covered bonds in foreign currency are obliged to enter into interest rate and foreign exchange hedges that have the same maturity as the corresponding covered bond. - A substantive share of transactions includes intra-group cross currency basis swap arrangements between the issuing mortgage company and the parent bank company, which in turn may hedge the FX risk via shorter term (e.g., three months) FX swaps. - Other counterparties include asset managers, pension funds and large international banks. - OTC trades are cleared and settled bilaterally. - Mortgage companies enter into cross currency swaps to obtain NOK in exchange for foreign currency raised through the issuance of the covered bond. ### Cross currency basis swap rates and funding stress - Cross currency basis swap rates indicate that tensions in this market, as witnessed during the global financial crisis (GFC), are currently muted. - Cross currency basis swap rates currently trade at a level close to zero, indicating that funding stress in U.S. dollar market is and has been muted, especially when compared with other major currencies, such as the euro. - The indicator suggests U.S. dollar funding stress in Norway during the NOK episodes of heightened volatility in particular between 2008, 2009, and in 2012. - The indicator points to muted levels of volatility since then, with U.S. dollar funding stress in Norway more limited than in other major economies. ### Money market reference rates (Nibor and NOWA) - Nibor: - The most commonly used reference rate in Norway is Nibor (Norwegian Interbank Offered Rate). - Nibor is administered by Norske Finansielle Referanser AS (NoRe). - Nibor is intended to reflect the interest rate a bank requires for unsecured money market lending in NOK to another highly-rated bank (lending rate). - Nibor is quoted at maturities of one week, and one, two, three and six months. - Three- and six-month Nibor are particularly widely used as benchmarks in financial contracts. - Given that domestic transactions in the interbank market or the issuance of CDs or CPs occur only occasionally, Nibor is in practice not transaction-based, and the 6 panel banks effectively base their submissions on estimates (expert judgement). - Nibor rates may vary significantly, especially on the shorter tenors, and are influenced by banks’ dollar funding spreads and the price of swapping U.S. dollar for NOK. - NoRe has applied for authorization under the BMR which entered into force in Norway on 20 December 2020. - The European Commission has initially classified Nibor as “uncritical” for an interim period. - NoRe foresees to improve the determination of Nibor rates by panel banks and to increase clarity on the determination of panel banks’ contributions. - The new calculation methodology introduces a waterfall approach: - Level A: interest rates from interbank lending to leading banks (as defined in current Nibor rules); - Level B: prices from sales of CDs; such CD rates would represent a borrowing rate, requiring an adjustment for the difference between lending and borrowing; - Level C: expert judgements; judgements should take into account relevant market information about the bank’s borrowing costs abroad, preferable actual transactions or committed quotes, and the bank’s committed quotes on CDs (such quotes shall be given at least 50 percent weight compared to expert judgments in the calculation of input data). - NOWA: - The NOWA rate is the interest rate on unsecured overnight interbank lending in NOK. - NOWA is soon (as of January 1, 2020) administered by Norges Bank and banks borrow and lend central bank reserves in this market. - In contrast to Nibor rates, the NOWA rate is usually calculated based on actual trades. - The NOWA panel currently comprises 11 panel banks that make daily submissions to Norges Bank. - Spreads in the unsecured overnight market (NOWA) are usually very small, and on average less than 1 basis point. - On quarter- and year-ends, activity in the unsecured overnight market may drop significantly as banks are reportedly unwilling to lend on these days; on days with low turnover, NOWA is calculated based on banks’ estimates, causing the NOWA rate to spike on such days. - On average, less than half of the 11 panel banks report daily lending activity to Norges Bank. - Norges Bank established a working group on alternative reference rates in NOK to establish an alternative reference rate for the Norwegian kroner. - A new ‘reformed NOWA’ benchmark rate was recommended by the working group; under the proposed new regime, Norges Bank will become the administrator for NOWA as from January 1, 2020. - The current system with panel banks will be discontinued and transition towards a transaction-based calculation of the rate, based on already available money market data (provided to Norges Bank). - On days with very low liquidity (insufficient number of transactions), the calculation will be based on a combination of historical data and actual traded data. - Considerable progress has been made and the timely transition towards the reformed NOWA regime by January 1, 2020 is very likely. ### Benchmark regulation and governance - Both administrators Norges Bank and NoRe have undertaken efforts to improve accuracy and integrity of the NOWA and Nibor benchmarks. - Both benchmarks aim at taking into account the International Organization of Securities Commissions (IOSCO) principles. - Subject to inclusion in the European economic area (EEA) agreement foreseen for the end of 2019, the EU Benchmark Regulation (BMR) will generally be applicable to the provision of benchmarks, the contribution of input data to a benchmark and the use of a benchmark by investors. - In the EU, the BMR is scheduled to enter into force as of January 1, 2020 for ‘uncritical’ benchmarks and as of January 1, 2022 for ‘critical’ benchmarks. - Norges Bank as a central bank administrator does not fall under the scope of the BMR but took the initiative to establish a working group on alternative reference rates in NOK. ### Sovereign bond markets: size, liquidity, and issuance - Outstanding government debt securities account for NOK 387 billion, representing only 18.2 percent of GDP. - Government borrowing is used to finance loans made by state lending institutions and it does not finance the national budget deficit. - Since 2015 Norges Bank has been operationally responsible for the management of government debt. - The Ministry of Finance (MoF) sets annually an upper limit for gross borrowing and a minimum average time to refixing. - Norges Bank formulates and publishes on an annual basis a debt management strategy which provides information on maximum annual issuance volumes for government bonds and T-bills. - Norges Bank has introduced measures to support liquidity in government securities markets and to ensure the benchmark status of government bonds: - A primary dealer (PD) system under which four PDs (Danske Bank, DNB, Nordea and SEB) have the sole right and obligation to participate in government bond auctions and are obliged to quote binding bid and offer prices on Oslo Børs for each government security. - PDs can enter into (one week) repo agreements with the government (via Norges Bank), under which they can borrow (up to a limit) government securities. - Norges Bank may buy back bonds with a residual maturity below one year. - All Norwegian government bonds are listed on Oslo Børs and can be traded on the stock exchange. - Only a small share of government bond trades takes place (electronically) on the exchange; most trades are performed bilaterally and electronic trading platforms such as MTS, Eurex Bonds, Tradeweb and Bondvision gained importance, complicating measurement and monitoring of overall liquidity conditions. - Norwegian government bonds are held predominantly by foreign investors; domestic banks and mortgage companies hold a share that is overall increasing but remains at a low level (of below 20 percent). - Banks hold government bonds as part of their liquidity portfolio and government bonds play an important role as HQLA level 1 asset to fulfil domestic LCR requirements. - Secondary market liquidity is considered to be low relative to other Nordic or European government markets, given the small size of the market. - Participants perceive Norwegian covered bonds overall to be more liquid than government bonds. - Secondary market activity measured by turnover ratio is overall stable, but at times appears to be more volatile and more susceptible to shocks (e.g., during 2014–15) than covered bonds or senior unsecured bonds. ### Bond market instruments (June 2019) — key outstanding amounts (In billions of Norwegian Kroner (NOK)) - Central government bonds: 386.8 (Instrument: Government of Norway; Maturities: ≤ 10 years) - Local government bonds: 110.0 (Instrument: Local governments) - Covered bonds: 587.5 714.0 (Instrument: Mortgage companies; Issued abroad: ≤ 11 years; Domestic: ≤ 6 years) - Financial institution senior unsecured bonds: 343.2 306.0 (Instrument: Large banks; Maturities: ≤ 5 years) - Corporate bonds: 216.2 34.0 (Instrument: Large corporates; Maturities: ≤ 10 years) - Foreign issuer bonds: 316.6 (Instrument: International organizations; Maturities: ≤ 10 years) - Public non-financial corporations: 114.3 310.1 (Instrument: Public non-financial corporations; Maturities: ≤ 15 years) ### Covered bond and senior unsecured bond markets; banks’ funding mix - The banking sector is the largest issuer in the Norwegian bond market. - Market-based funding represents a share of 50 percent of banks’ liabilities. - Covered bonds have become the banks’ most important funding source since the introduction of covered bond legislation in 2007. - Covered bonds represent approximately 50 percent of market-based funding; senior unsecured bonds account for a stable share of 20 percent. - The importance of short-term wholesale and interbank funding has been following a decreasing trend since 2007, now accounting for approximately 30 percent of total market-based funding. - The funding mix may differ considerably across individual Norwegian banks: - Norway’s largest bank currently strongly resorts to short-term wholesale funding, representing a share between 40 and 50 percent in recent years. - Smaller banks without access to short-term wholesale funding markets abroad rely on short-term wholesale funding to a much lesser extent (approximately 20 percent). *Source: IMF staff summary of the referenced chapter.* ### 30. Banks are increasingly resorting to funding abroad; today, the slight majority of ### 30. Banks are increasingly resorting to funding abroad; today, the slight majority of ### Funding composition and currency breakdown - 46 percent of covered bonds outstanding were issued in NOK, 54 percent were issued in foreign currencies. - Foreign currency composition: mainly in euro (48 percent), U.S. dollar (4 percent) and other currencies (3 percent, e.g., Swedish krona). - Large discrepancies across issuers: smaller issuers normally focus on issues in domestic currency; large issuers rely more on issuance in foreign currency. - The largest covered bond issuer (DNB Boligkreditt) has issued a share of 80 percent of its covered bonds in foreign currency. - Largest banks also issue long-term senior unsecured debt abroad through EMTN programs, swapping proceeds back to Norwegian kroner. ### Domestic investor base and market liquidity - A large share of covered bonds is held by banks; approximately 50 percent of domestic covered bonds is held by financial institutions. - Covered bonds considered a liquid and high credit quality investment serving as a substitute for Norwegian government bonds. - Covered bonds are important as HQLA level 1 assets for domestic banks to fulfil domestic LCR requirements. - Other covered bond investor groups: pension funds, insurance companies and foreign investors. - Secondary market liquidity is stable; Norges Bank money market survey: market participants consider covered bonds to be overall more liquid than government bonds. - Oslo Børs measures to improve secondary market liquidity: - Since June 2014, large size benchmark covered bonds are subject to continuous indicative quotation. - Nordic Bond Pricing provides independent pricing services on a daily basis. ### Senior unsecured issuance - Senior unsecured bonds complement longer-term market-based funding. - Relevance of senior unsecured bonds has decreased and been substituted by covered bonds. - Issuance amounts have increased slightly recently but overall been rather stable since 2011; a slightly increasing share is issued abroad, mainly in Europe. - Investor spectrum predominantly real-money investors: asset managers, pension funds and life insurers, and foreign investors. ### Regulation related to liquidity risk (LCR and NSFR) - Norwegian liquidity regulation essentially mirrors EU legislation for credit institutions (entered into force in EU in January 2014). - Banks’ total LCR levels are stable and range above the 100 percent minimum. - U.S. dollar LCR and euro LCR are more volatile, though at higher absolute levels. - FSA monitors institutions’ compliance with LCR requirements on a monthly basis (off-site, regular reporting based on EU-framework). - LCR requirements in Norway: - LCR-total (all currencies): a minimum requirement of 100 percent applies; applicable since December 31, 2015 with a step-up plan over two years (70 percent in 2016 and 80 percent in 2017) and 100 percent since year-end 2017; for systemically important financial institutions (SIFIs) 100 percent has been the minimum requirement since December 31, 2015. - LCR-NOK (local currency): a minimum requirement of 50 percent applies, if institutions have EUR or USD or both as significant currency; for other institutions, no formal minimum requirement applies, however the FSA expects financial institution's LCR-NOK to be close to their LCR-total; the minimum requirements have been in force since September 30, 2017. - LCR in other significant currencies than NOK: a minimum requirement of 100 percent applies; this requirement is in place since September 30, 2017, although for the non-SIFIs the minimum requirement was 80 percent from September 20 to December 31, 2017 to correspond to the step-up-plan for the LCR-total. - NSFR: - The NSFR is a reporting requirement; financial institutions are required to report NSFR information (all currencies and per significant currency) on a quarterly basis. - Currently, no minimum requirement is applied. - Banks' NSFR levels follow a slightly increasing trend since 2014. - Liquidity regulation influences banks’ investment decisions and HQLA portfolios: international issuers with zero risk weight, government bonds and covered bonds dominate HQLA holdings. - FSA closely monitors use of covered bonds and concentration in HQLA portfolios at asset class level and at issuer level. ### Vulnerabilities and sectoral liquidity notes - NOK LCR requirement may contribute to heightened volatility in Nibor rates at quarter and year end or during episodes with increased structural liquidity swings. - Large banks may at times be close to the 50 percent LCR-NOK limit; large outflows from banks’ accounts to the government account at Norges Bank may trigger structural liquidity shocks. - Interbank market generally has maturities below 30 days and may be unsuitable to manage LCR ratio; multiple banks may be forced to borrow in the FX swap market to lend at maturities beyond 30 days, contributing to Nibor rate increases. - Securities Fund Act regulates mutual funds and fund managers; measures mitigate liquidity risk including limits on leveraging, diversification requirements, and fair-value based valuation. - Mutual fund sector size and composition: - Assets under management amounting to NOK 1.129 billion, representing 32 percent of GDP. - Equity funds hold the largest share (53 percent), bond funds (27 percent) and money market funds (9 percent). - Sector currently appears to pose little systemic liquidity risk, but monitoring remains relevant given increased liquidity risk at fixed-income focused funds. ### Norges Bank’s liquidity management — normal times and operations - Regulation on Monetary Policy (March 2, 2018) defines Norges Bank’s inflation targeting: operational target is inflation close to two percent over time; inflation targeting should be forward looking and flexible to contribute to high and stable output and employment, and to counteracting financial imbalances. - Correlation: policy rate (sight deposit rate) and NOWA rate overall rather high; spikes in NOWA at quarter or year-end reduce correlation. - Money market segments correlate well with Norges Bank’s key policy rate; spreads vary significantly, especially on shorter tenors;FX swap market developments impact local Nibor rate. - Quota system introduced in 2011: - Restricts level of banks’ reserves remunerated at key policy rate; additional reserves remunerated at reserve rate (1 percent below sight deposit rate). - Quotas assigned to eligible counterparties and updated twice a year based on total assets. - Bank grouping by total assets: - Group 1: DNB Bank ASA, NORDEA, Danske Bank, Handelsbanken, SEB (Oslofilialen) and Swedbank Norge. - Group 2: 15 mid-size banks. - Group 3: remaining smaller 105 banks. - Transition rule: a bank that quotes money market rates and that in principle belongs to group 2 will be moved to group 1 when the bank's quota is to be set. - The sum of all quotas (of currently NOK 45 billion) is slightly above the targeted level of reserves (of NOK 35 billion, +- 5 billion). - Structural liquidity management challenges: - High amount and increasing volatility of structural liquidity complicate liquidity forecasting and calibration of OMOs. - Structural liquidity conditions strongly influenced by government transactions; Norges Bank conducts both liquidity providing and absorbing operations to sterilize government transactions. - Transactions linked to the Government Pension Fund Global (GPFG) are a comparatively small and stable component; issuance or maturity of government securities may have substantive impact on structural liquidity but associated risks and forecasting errors are comparatively small due to transparent MoF debt management strategy. - Liquidity forecasting relies on informal information exchange between Norges Bank and the Ministries; Norges Bank publishes forecast for structural liquidity two times a week on their website. - Operational tools and practices: - Norges Bank steers bank reserves mainly through F-loans and F-deposits; these are used at high frequency to provide liquidity insurance with varying maturity depending on expected structural liquidity developments. - F-loans and F-deposits have a floating interest rate normally determined by multi-price auction. - Standing facilities: overnight D-loans and deposits at the reserve rate. - Fine-tuning operations undertaken late in the day if reserves deviate from desired level. - Amendments improving operational framework to mitigate quarter- and year-end liquidity stresses: - Market operations at quarter-end and year end: additional F-loans at the last trading date of each quarter at fixed rate, full allotment, maturity three month (loans mature at the first trading day of the following quarter) and priced at the key policy rate +15 basis points; these provide a backstop on days with limited interbank liquidity. - Change of settlement date for some F-loans: selected F-loan auctions to be settled two business days after the auction day (t+2) on days with strong declines in structural liquidity; reduces operational and financial risks related to banks’ liquidity management and collateral mobilization. - Change to floating interest rate for market operations: allotted interest rates can be adjusted for operations that span monetary policy meetings; if the key policy rate is changed during the maturity of the operation, banks’ allotment rate will change accordingly; intended to improve liquidity management and reduce underbidding/overbidding risk linked to expected policy rate adjustments. ### Counterparty and collateral frameworks - Counterparty framework is broad; eligible counterparties: - Commercial banks and savings banks headquartered in Norway; - Branches in Norway of banks and credit institutions headquartered in another state; - Banks and other credit institutions permitted to market and provide services in Norway from a commercial presence in another EEA state (cross-border services); - On a case-by-case basis, limited access is provided to credit institutions that provide cross-border services in Norway from state outside the EEA. - Collateral framework is broad and includes bonds, notes and short-term papers, units of bonds and money market funds, fixed deposits in Norges Bank, and deposits in other central banks. - Detailed rules and guidelines for accepting collateral are regulated via the Guidelines for pledging collateral specifying eligibility criteria, haircuts depending on asset category, interest type and time to maturity, and valuation procedures. - Collateral valuation: - Priority to market prices from different market sources. - If adequate market prices not available (older than 21 business days), Norges Bank calculates and applies a theoretical price for NOK denominated securities or—for foreign denominated securities—applies a price based on the nominal amount with deduction of an extra haircut. - Recent observations: around 30 percent of mobilized eligible securities have a theoretically determined price. - Pricing based on the nominal amount is applied only rarely, for approximately two percent of eligible securities. - Norges Bank monitors and publishes aggregate information on recourse to Norges Bank credit and amounts of collateral mobilized; more detailed information on use of individual asset classes as collateral is lacking and information on the overall universe of eligible collateral appears incomplete. *Source: IMF staff compilation from the provided chapter content.* ### 52. Liquidity stress events can be distinguished by type of event—idiosyncratic or ### 52. Liquidity stress events can be distinguished by type of event—idiosyncratic or systemic—and whether stress is in domestic or foreign currency ### Liquidity event types and instruments - Liquidity stress events are distinguished by type of event—idiosyncratic or systemic—and by currency (domestic or foreign). - Idiosyncratic events are addressed through lender of last resort actions—or Emergency Liquidity Assistance (ELA). - System-wide disruptions to pricing and distribution of liquidity across the financial sector, including securities markets, require different approaches and responses. - Table of instruments (as presented): - Norwegian Kroner, Idiosyncratic—Norges Bank: Financial institutions—ELA policy. - Norwegian Kroner, Systemic—Norges Bank: F-loans with expanded maturities and/or against a broadened set of collateral and/or at rate terms deviating from standard market operations, D-loans against broadened set of collateral; Markets—2008–2014 Ministry of Finance: Direct support to securities markets (e.g., via asset swap with Norges Bank in operating role). - Foreign Currency, Idiosyncratic—Norges Bank: Norges Bank Act provides for capacity to provide ELA in foreign exchange. - Foreign Currency, Systemic—Norges Bank: Foreign exchange swaps (e.g., in euro and U.S. dollar); Foreign currency loans (e.g., in euro and U.S. dollar). ### ELA legal basis, eligibility, and governance - Legal basis: - The Norges Bank Act of 1985 provides the central bank with a sound legal basis to perform its lender-of-last-resort (LOLR) function and to provide liquidity support in different forms. - Norges Bank can provide liquidity support in domestic and foreign currency. - Eligible institutions: - Eligible institutions include both banks and nonbank financial institutions (NBFIs). - Norges Bank provides ELA only to domestic financial institutions and subsidiaries of foreign institutions. - Branches of foreign banks are explicitely not eligible. - Recent communication clarified that banks in resolution may be considered eligible for ELA. - Branches of Norwegian institutions established and operating in other EEA countries would request ELA with Norges Bank. - Application guidelines: - Norges Bank has published concrete guidelines for applying for ELA (“credit on special terms”) specifying required information: profit and loss and capital adequacy calculations, forecasts on income and capital adequacy, a plan for recapitalization of the bank, liquidity reports, liquidity buffers, information on funding, mark-to-market values of securities portfolios and off-balance sheet portfolios, impairment of loans and other claims. - Decision-making and coordination: - Norges Bank has an internal framework outlining roles, responsibilities and procedures for bilateral ELA assessment and provision. - Upon an ELA request, Norges Bank informs the Financial Supervisory Authority (FSA) and the Ministry of Finance (MoF). - Norges Bank’s Executive Board or the Governor (under a general mandate) makes the decision on granting ELA and the parameters applied. - The decision includes a forward-looking assessment and judgment on the solvency of the requesting bank, performed by the FSA. - A Memorandum of Understanding between Nordic-Baltic central banks specifies ELA requests should be submitted to the home central bank. ### Collateral framework and operational preparedness - Collateral acceptance: - The capacity to accept non-standard collateral is currently somewhat constrained; a framework to accept loans or loan portfolios has yet to be tested with counterparties. - Recent amendments to the Financial Collateral Act now allow Norges Bank to accept mortgage loan portfolios as collateral, substantially broadening the collateral base. - Norges Bank has initiated preparatory work to assess, value and mobilize portfolios of non-defaulted residential mortgage loans, envisaging collaboration with Finance Norway and selected domestic banks and tests related to transfer and processing of mortgage loan portfolio information. - Past operational expansions: - During the Global Financial Crisis (GFC), Norges Bank: - Administered on behalf of the government a swap arrangement allowing domestic banks to swap covered bonds against government securities. - Introduced F-loans (fixed rate loans) with extended maturities of three years, particularly to support smaller domestic banks. - Temporarily widened its collateral framework, suspended ratings requirements, accepted banks’ claims on mortgage companies issuing covered bonds and accepted a subset of previously ineligible units in Norwegian money market funds. ### Monitoring, inter-agency interaction, and exercises - Monitoring: - Norges Bank monitors liquidity conditions in short-term domestic and foreign currency funding markets through contacts with issuing banks, investors and a monthly Liquidity Survey. - The six largest Norwegian banks participate in the survey, which includes volumes and prices for all CP and CD issues (only the largest bank) and issuing banks’ qualitative judgment of market conditions. - An internal coordination group (chaired by Financial Stability Department) with representatives of Monetary Policy, Financial Stability and Market Operations Departments reports on funding and liquidity developments to the Executive Board at least once a year. - Inter-agency exchange: - Norges Bank, FSA and MoF exchange information on relevant market conditions. - Norges Bank and FSA hold 8−9 bilateral meetings per year and exchange complementary information on liquidity and funding situations. - Norges Bank, the FSA and the MoF conduct triparty meetings at least twice a year. - Inter-agency arrangements appear limited to information exchange; roles and responsibilities for implementation of market support are less clearly specified and may be determined on an ad hoc basis. - Crisis simulation: - In January 2019, a crisis simulation exercise among Nordic-Baltic authorities took place; Norges Bank participated to a limited extent and simulated providing Norwegian kroner in a swap arrangement with the Central Bank of Denmark to enable ELA in Norwegian kroner to a large Danish bank with a branch in Norway. ### Foreign currency operations, reserves, and constraints - Operational framework for FX support: - Foreign exchange swaps and foreign currency loans form part of Norges Bank’s operational framework and can be activated in case of liquidity stress. - Foreign exchange swaps: - Available to complement F-loans and provide supply of liquidity in foreign currency at different maturities. - May be made available to a broadened set of counterparties. - During the 2008−09 financial crisis, Norges Bank provided foreign exchange swaps at different maturities (up to three months) in U.S. dollar (US$26.9 billion) and in euro (EUR 9.9 billion). - Foreign currency loans: - Can be provided to domestic banks against collateral and at different maturities. - Complement swaps as they do not directly affect kroner liquidity in the interbank market. - During the 2008–09 financial crisis, Norges Bank provided collateralized foreign currency loans at different maturities (up to three months) in U.S. dollar (US$27.0 billion). - Limits on provision: - Provision of foreign currency funding—idiosyncratic or system-wide—is contingent on access to foreign-currency funding. - Norges Bank’s ability to respond depends on foreign exchange reserves and access to foreign currency swap lines with foreign central banks. - Foreign exchange reserves (exact figures and composition): - Aggregate market value of foreign exchange reserves currently NOK 517.3 billion (13.7 percent of GDP). - The portfolio encompasses an equity portfolio and a fixed income portfolio. - The fixed income portfolio represents 80 percent of the portfolio and is invested in cash deposits and Treasury bills and sovereign bonds issued by France, Germany, Japan, the United Kingdom (U.K.) and the U.S. - Half of the fixed income portfolio is invested in U.S. dollar, 34 percent in euro, British pound and Japanese yen each represent a share of 8 percent in this portfolio. - The equity portfolio contains liquid equities listed on a regulated and recognized exchange. - Swap lines: - Norges Bank entered into a bilateral currency swap agreement with the U.S. Federal Reserve in September 2008; this arrangement is currently inactive and no other swap arrangements exist. ### Market functioning and systemic liquidity risks - Government bond market: - The government bond market is small compared to other European peers and has limited capacity as a safe haven in downturns. - Small market size impacts secondary market liquidity; the market is perceived as sensitive to market volatility and provides a benchmark curve not to its full extent due to limited maturities and availability to domestic investors. - Bank funding structure and risks: - Norwegian banks’ continued high reliance on market-based funding may pose risks to financial stability and systemic liquidity. - Risks are aggravated by large amounts of banks’ cross holdings; domestic banks are the most important investor class for domestic covered bonds. - Shocks in the housing market (e.g., a broad-based and sharp decline in house prices) could impair functioning and liquidity of covered bond markets, trigger a broad-based increase in banks’ funding costs or require deleveraging. - Covered bonds provide long-term funding with comparatively low credit risk and have partially substituted riskier wholesale funding (senior unsecured and short-term wholesale funding), supporting bank funding stability. - Liquidity regulation interactions: - Monitoring of LCR requirements should account for side effects and interactions with bond and money market activity. - Banks’ covered bond investments are driven by LCR requirements and limited availability of government bonds requires investment in other HQLA instruments, notably covered bonds. - Continued close monitoring of HQLA portfolio composition is crucial. - The LCR requirement in domestic currency is currently at 50 percent; increasing it further at the current juncture would likely increase banks’ reliance on covered bonds and cross holdings, raising concentration and secondary market liquidity concerns. - Investor base and FX funding: - Reliance on foreign investors diversifies the investor base but increases vulnerability to foreign investor sentiment. - Some large Norwegian banks strongly rely on short-term and long-term market-based funding in FX. - Short-term FX funding stress observed during the GFC has been muted recently; Norwegian banks’ high credit quality currently supports access to FX funding markets. - Growing covered bond issuance in the euro area increases susceptibility to shocks in demand. - Market segments: - FX swap markets function well and are resilient in stress; central clearing via LCH Clearnet reduces counterparty risk. - Short-term (overnight) FX swaps are liquid and resilient with high turnover and many active counterparties (domestically and in London, New York). - FX spot market is less resilient; activity concentrated among a small number of domestic and Nordic counterparties, leading to potential scarcity of liquidity at times. - Cross-currency basis swap market is small with lower turnover and fewer counterparties but was comparatively resilient during recent stress episodes; growing demand for hedging may raise costs and counterparty risk, although limits on counterparty exposures and one-way margining in covered bond legislation contain risk. - Regulatory developments: - Bank Recovery and Resolution Directive (BRRD) and the EU securitization regulation may change the universe of financial instruments in Norway. - It is uncertain whether senior nonpreferred bonds will substitute or replace senior unsecured bank bonds. - The EU securitization regulation could facilitate securitization of a broadened range of cash flow generating assets in the Norwegian market. ### Recommendations and key supervisory actions noted - The FSA should continue efforts to complete transition towards a Nibor benchmark in line with the BMR to ensure market integrity. - The FSA should complete the authorization process to ensure a swift transition towards a renewed Nibor reference rate. - Nibor is expected to continue to be determined largely based on panel banks’ estimates, not transactions; NoRe as administrator should ensure panel banks’ estimation process (waterfall) is transparent and comprehensible. - Continued monitoring priorities: - Close monitoring of HQLA portfolio composition by Norges Bank and the FSA. - Continued monitoring of interaction between money market functioning and liquidity regulation, including the domestic currency LCR requirement (currently at 50 percent). - Monitor implications of banks’ reliance on market funding and covered bond concentration and cross holdings. *Source: IMF Staff (excerpts from Norway country chapter).* ### 75. Norges Bank’s operational framework works well overall. Norges Bank is able to ### 1norea2020006 - 75. Norges Bank’s operational framework works well overall. Norges Bank is able to ### Operational framework and structural liquidity - Norges Bank’s operational framework "works well overall" and is able to manage the challenging structural liquidity conditions. - Liquidity forecasting and regular open market operations, at times at large amounts, provide an effective operational framework and transmission of policy signals, as expressed by a high level of correlation of the policy rate and short-term money market rates. - Large swings in structural liquidity pose a risk for market functioning if Norges Bank fails to counteract fluctuations in structural liquidity. - The previous floor system (without quotas) required comparatively lower needs for forecasting liquidity and was connected with lower amounts and frequencies of open market operations. - Reserve balances perform multiple functions: - steering money market interest rates; - supporting money market activity; - serving as a liquidity buffer under the LCR-regime, insulating the domestic system from offshore or domestic shocks. - The current setup is considered adequate to balance these objectives. - Operational risks associated with F-loan operations are mitigated to a large extent because under the pooling system counterparties have generally pre-deposited sufficient amounts of eligible assets usable as collateral for F-loans. ### Market frictions at quarter- and year-end; regulatory interaction - Banks’ unwillingness to lend at quarter and year end hampers market functioning and creates market frictions around these dates. - Norges Bank has introduced dedicated facilities providing a liquidity backstop around these dates to limit risks associated with market freezes. - Banks’ behavior appears driven in particular by capital and leverage ratio requirements and by contributions to the deposit insurance fund being determined based on balance sheet size at quarter and year end. - Recommendation: - The FSA should assess whether regulatory ratios and contributions could be determined based on “averaging” (i.e., the average size of the balance sheet over a predefined period) to better account for the interaction between regulation, policy implementation and market functioning. - On that basis, Norges Bank may reassess the conduct and calibration of its F-loan operations over quarter- and year end. ### Collateral framework and monitoring - Information about Norges Bank’s collateral framework’s interaction with liquidity regulation is somewhat limited; this may negatively impact efficiency and effectiveness of monetary policy implementation and liquidity regulation. - The current broad collateral framework provides overall sufficient amounts of collateral; however limited information is monitored and analyzed regarding: - amounts of eligible collateral issued (domestically and abroad); - eligible collateral available to counterparties; - types of assets mobilized as collateral; and - related developments over time. - Suggested analyses to provide insights into: - Norges Bank’s risk taking in connection with liquidity provision and exposure to individual sectors or regions; - overall use of individual assets as collateral and its impact on secondary market liquidity; - aggregate and individual levels of unencumbered assets eligible as collateral (a good indicator for the quantitative impact and effectiveness of individual collateral measures, e.g., if further broadening of the framework is needed); - interaction between monetary policy implementation and liquidity regulation and banks’ availability and use of HQLA to meet LCR requirements. - Clarifying monitoring would help identify discrepancies between amounts of eligible collateral and available collateral, which may be substantial given the comparatively large and increasing role of foreign investors. ### Market-wide liquidity support and securities market intervention - Norges Bank is prepared to provide market-wide liquidity support to eligible institutions; the framework is adaptable and scalable to expand amounts and maturities and to broaden counterparties or eligible collateral. - Norges Bank can rely on facilities and procedures activated during the 2008–09 financial crisis; procedures and roles and responsibilities of involved business areas are specified and documented. - Uncertainty exists on how stress in securities markets will be dealt with; clarity is needed on responsibility for monitoring securities markets and a framework for intervention. - Further coordination with the MoF and the FSA is needed to prepare and conduct market support effectively. - Elements that a securities market intervention framework should incorporate: - articulating objectives of interventions (mainly preserving financial stability); - identifying markets most important for preserving financial stability; - identifying potential triggers for intervention; - establishing principles for design of programs; - defining roles among authorities for program design, risk taking, operation, communication, and exit strategy; - addressing implementation issues such as coordination with other crisis management actions. ### Bilateral liquidity support (ELA) preparedness - Further work may be needed on preparedness to provide ELA. - The Nordic crisis simulation exercise and envisaged tests related to mobilization of loan portfolios as ELA collateral provide a good starting point to test and establish reliable procedures for crisis use. - Recommended additional tests and simulations: - involvement of Norges Bank counterparties: conduct tests with domestic systemically important banks (D-SIBs) and selected mid-sized banks to simulate procedural aspects of an ELA assessment and provision (“pre-positioning”); - simulating procedures related to the assessment of the ELA request: simulate information provision, assessment by Norges Bank business areas and the FSA, including solvency and viability assessment and determination of ELA parameters (amount, duration, applicable interest rate, other conditions) and decision making; - simulating procedures related to mobilization of non-standard ELA collateral: include mobilization and legal transfer of non-standard collateral (e.g., mortgage loan portfolios, equities), collateral eligibility assessment, and pricing and haircut determination. ### Constraints on accepting loan portfolios as ELA collateral; recommended framework elements - There is a risk that ELA provision may be impaired by operational inability to accept bank loans or portfolios as collateral. - Norges Bank’s capacity to accept mortgage loan portfolios is currently constrained mainly because rules and procedures have not yet been tested with counterparties. - Norges Bank should continue preparatory work on acceptance of mortgage loan portfolios to improve the ELA framework. - A robust ELA framework for loan-portfolio collateral should cover: - rules about the legal transfer of eligible loans or loan portfolios; - eligibility criteria and minimum requirements at individual loan-level: credit quality, loan size, maturity, amortization schedules, underlying collateral (residential mortgages), place of establishment of the debtor; - eligibility criteria and minimum requirements at portfolio level: portfolio size, composition (homogeneity on underlying collateral, geographical distribution, debtor concentration), credit quality; - valuation and risk control measures: valuation methodology and frequency, determination of haircuts to mitigate financial risks, over-collateralization; - procedural aspects: timely and accurate exchange of a predefined set of static information and required update frequencies (per loan and at portfolio level) with the counterparty in a predefined format. - Norges Bank should intensify monitoring availability of ELA-eligible collateral, in particular for the D-SIBs and for medium size banks, and use this information in an early warning system (“horizon-scanning”). ### Liquidity support in FX and international cooperation - International reserves are adequate in size and liquid. - Norges Bank should continue international cooperation with other central banks to ensure swift coordinated action in a severe financial crisis. - Norwegian banks’ exposure from subsidiaries abroad is limited, but funding in euro is significant and in times of market stress elevated demand for euro liquidity could emerge. - The swap arrangement (reciprocal currency arrangement) with the Federal Reserve Bank of New York proved supportive during the global financial crisis. - Norges Bank should continue cooperation with relevant central banks to be ready to contribute swiftly to coordinated actions to address funding pressures. ### Appendix I — Norwegian covered bonds: market overview and key statistics - Market growth: The Norwegian covered bond market has been growing continuously since 2007. - Active issuers: 24 active issuers. - Aggregate outstanding: 1,258 billion NOK. - Share of GDP: 32 percent of GDP. - Largest issuers (shares of total outstanding volume): - DNB Boligkreditt: 37 percent; - SpareBank 1 Boligkreditt: 19 percent; - Eika Boligkreditt: 7 percent; - Nordea Eiendomskreditt: 7 percent. - Issuance abroad and in foreign currency: 54 percent of covered bonds. - Breakdown of issues abroad: euro 48 percent, U.S. dollar 4 percent, other currencies 3 percent. - Most covered bonds are backed by residential mortgages; commercial mortgage-backed covered bonds are <3 percent of outstanding volume. - Domestic covered bonds: usually variable rate coupon and maturities up to 5 years. - Covered bonds issued abroad: usually fixed rate coupon and maturities up to 10 years. ### Appendix I — Legal framework, issuance structure, supervision, and cover pool rules - Norwegian Covered Bond legislation entered into force on June 1, 2007. A new Norwegian Act on Financial Institutions came into force in January 2016, amending the previous legal framework. - Norwegian legislation complies with the Capital Requirements Regulation (CRR). CRR-compliant covered bonds are eligible for a reduced 10 percent risk-weighting under the standard method for capital adequacy requirement. - If denominated in euro, they are also eligible as collateral under Eurosystem rules and generally qualify as liquid assets under the LCR regime. - In April 2019 the European Parliament provisionally approved a new Covered Bond Directive; finally approved 27 November 2019; scheduled to enter into force by 8 July 2022. (MoF requested FSA input; public hearing based on FSA letter is lasting until 17 August 2020.) - Issuer structure: - Covered bonds in Norway can be issued by specialized credit institutions (mortgage companies) only. - Majority of issuers: 20 are subsidiaries of individual parent banks; a few issuers (5) are owned by groups of smaller banks. - Supervision: - Norwegian issuers are subject to a supervisory regime involving an independent inspector and the FSA-appointed independent cover pool inspector. - The cover pool inspector monitors compliance with the cover register and asset coverage test on a quarterly basis and reports annually to the Norwegian FSA. - Cover pool composition and constraints: - Dominated by residential mortgages; substitute assets may amount to a maximum of 20 percent of the cover pool (exemptions up to 30 percent may be granted by the FSA; only granted once after the 2008 crisis). - Underlying assets must be originated by the issuer and located within the EEA or OECD. In practice, Norwegian cover pools marginally contain nondomestic assets. - Loan-to-value (LTV) limits: 75 percent for residential mortgages; 60 percent for holiday/leisure properties and commercial mortgages. - Current LTV levels in cover pools are overall well below the 75 and 60 percent thresholds. - Asset segregation: - Secured through the cover register managed by the issuer; assets remain with the estate if issuer is placed under public administration. - Bondholders and derivative counterparties have exclusive, equal and proportionate claims and equal rights to over-collateralization. - Asset-liability management: - Strict mark-to-market principle: value of cover pool must at all times exceed the value of preferential claim of covered bond holders. - Legally binding over-collateralization level: 2 percent. - Rating agencies require about 4 percent over-collateralization for AAA-rating. - Maximum exposure to one single borrower limited at 5 percent of the cover pool when running coverage tests. - Issuers must establish limits on interest rate risks and are not allowed to take on substantial FX risk. - Cash flow matching and regular stress tests are required. - Insolvency of the issuer: - Mortgage company placed under public administration (not declared bankrupt). - Covered bond program administered by bankruptcy administrator or a public administrator appointed by the MoF with powers to sell assets, issue new bonds, and enter derivative agreements to meet preferential claims. ### Appendix II — Assets qualifying as Liquid Assets in LCR (selected entries) - Level 1 (haircut percent): Cash 0; Central bank deposits 0; Government securities 0; Claims to international organisations or multilateral investment banks 0; Securities issued by Norwegian local authorities and public institutions 0; Covered bonds (within EU/EEA), risk class 1 (conditions apply) 7. - Level 1, excluded covered bonds: Shares in mutual funds: Cash and central bank deposits 0; Level 1 assets, excluded covered bonds 5; Level 1 approved covered bonds 12. - Level 2A (haircut percent): Securities issued by EU/EEA local authorities and public institutions 15; Exposures to third countries 15; Covered bonds (within EU/EEA), risk class 2 (conditions apply) 15; Covered bonds (third countries), risk class 1 (conditions apply) 15; Corporate bonds, risk class 1 15; Shares in mutual funds, level 2A assets 20. - Level 2B (haircut percent): Asset-backed securities (RMBS/ABS) 25 / 35; Corporate bonds, risk class 3 50; Shares listed at main stock market 50; Covered bonds (conditions apply) 50; Loans secured by residential real estate or vehicles 30; Level 2B approved covered bonds 35; SME loans, unsecured consumer loans 40; Corporate bonds and shares 55. - Source of LCR table: Regulation on calculation of liquid assets, outflows and inflows in the LCR. https://lovdata.no/dokument/SF/forskrift/2015-12-22-1841 (Norwegian). *Source: 1norea2020006 (IMF).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1norea2020006.pdf_