## _cr05200 - 2005. The findings were further discussed with the Norwegian authorities during the Article IV consultation ## Source details **Canonical URL:** [_cr05200 - 2005. The findings were further discussed with the Norwegian authorities during the Article IV consultation](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05200.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05200.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05200.pdf.json) --- ### Mission composition and context - Article IV consultation mission in March 2005. - Team: Mark Swinburne (mission chief), Thordur Olafsson (deputy mission chief), Ritu Basu, Nigel Davies, Jan Woltjer, Virginia La Torre (all IMF/MFD); Etibar Jafarov (IMF/EUR); Peter Pfund (formerly Swiss Federal Office of Private Insurance); Saul J. Carpio (U.S. OCC); Jacob Hostrup Andersen (Danish FSA). - FSAPs assess stability of the financial system as a whole and do not cover risks specific to individual institutions such as asset quality, operational or legal risks, or fraud. ### Executive summary — overall assessment - Norway’s financial system: sound, well managed, and competitive; short-term vulnerabilities low overall. - Contributing factors: - Improved macroeconomic conditions since mid-2003. - Historically low interest rates. - Prudent and transparent frameworks for monetary, fiscal, and financial stability policies. - Government Petroleum Fund (GPF) provides significant insulation against sharp oil-price movements. - Financial sector regulation closely aligned with EU norms through EEA participation. - Principal medium- to long-term risk: rising household debt levels and associated house price inflation. - Authorities proactive; early producers of published financial stability analyses. ### Main findings — banks - Soundness and capital - Banks generally have sound capital positions; overall capital adequacy ratio about 12 percent (stable). - Regulatory capital/ RWA: 2002: 12.15; 2003: 12.36; 2004: 12.16. - Tier 1 Capital/ RWA: 2002: 9.60; 2003: 9.72; 2004: 9.76. - Earnings and asset quality - ROAA: 2002: 0.40; 2003: 0.58; 2004: 0.85. - ROAE: 2002: 6.18; 2003: 9.61; 2004: 14.62. - Non-performing loans (NPL)/ Gross lending: 2002: 1.83; 2003: 1.59; 2004: 0.97. - Loan loss provision/NPL: 2002: 29.21; 2003: 33.12; 2004: 36.75. - NPL net of loan loss provision /Tier 1 capital: 2002: 17.12; 2003: 14.31; 2004: 8.24. - Funding, liquidity and structure - Total loans/Total assets: 2002: 80.48; 2003: 79.50; 2004: 81.32. - Mortgages/Total loans: 2002: 49.22; 2003: 52.02; 2004: 55.61. - Loans net of provisions/Deposits: 2002: 119.55; 2003: 125.21; 2004: 127.47. - Liquid asset/Short-term liability: 2002: 56.46; 2003: 58.91; 2004: 59.26. - Concentration and systemic features - Households account for about 70 percent of gross lending (up from ~60 percent in early 1990s); about 80 percent of household loans are mortgages; about 85 percent of household loans carry floating interest rates. - DnB NOR large market share (38.5 percent in Jun 2004); top banks concentrated — assets of top five banks/Total banking sector asset: 2002: 58.86; 2003: 59.63; 2004: 60.85. - Many banks are parts of wider financial groups (conglomeration) increasing potential cross-sector contagion in extreme events. - Vulnerabilities and risk management - Main source of risk: credit risk, notably household mortgage growth and rising household debt-to-disposable-income (household debt/ GDP: 2002: 72.67; 2003: 77.66; 2004: ...). - Stress testing and bank internal tools: standard mortgage stress test includes a 500 basis point mortgage interest rate increase. - Anticipation of lower regulatory capital under Basel II for mortgage exposures may have contributed to mortgage growth; FSAN should consider Pillar 2 responses. ### Main findings — insurance and pensions - Life insurance and pensions - Life insurance sector dominated by private pension products; 95 percent carry a guaranteed rate of return. - Initial solvency ratio (life): 157.6. - Key vulnerabilities: obligation to meet guaranteed returns in low-interest-rate environment; asset-liability mismatches due to a shortage of longer-term NOK investment opportunities. - Bonds held to maturity (life insurers): 2001: 72 548; 2002: 124 673; 2003: 166 206; 2004: 165 405. - Equities and units (current assets) for life insurers: 2001: 80 127; 2002: 30 497; 2003: 55 440; 2004: 79 812. - Non-life insurance - Initial solvency ratio (non-life): 338.7. - Total assets (non-life): 2001: 39 184; 2002: 40 674; 2003: 48 745; 2004: 55 278. - Non-life sensitivity concentrated on provisions and underwriting exposures. ### Markets, liquidity, payments and securities settlement - Money and FX markets - Markets small but well-functioning and adequately liquid in normal times; Norway joined CLS in 2003 reducing FX settlement risk. - About 10-11 market players quote firm FX prices. - Short-term interbank money market less active; quotations often indicative. - Collateral and central bank facilities - Banks hold large shares of excess reserves at central bank overnight facility. - Recommendation: reduce bank bonds as collateral from 50 percent to 35 percent; align domestic and foreign bond requirements; introduce maximum exposure limit to a single issuer. - Liquidity requirement: no reserve requirement; a 6 percent liquid asset requirement exists but is described as outdated and no longer binding overall. - Payments and securities settlement - NBO (RTGS) settles interbank payments above NOK 25 million; NICS clears interbank payments below NOK 25 million and retail payments (value of retail payments via NICS: NOK 14,409 billion or around 27% of all payments in 2004). - Tiered settlement structure: ~120 smaller banks settle indirectly through settlement service providers; DNB-NOR accounts for almost 40% of the banking market. - Identified needs: - Strengthen risk management in VPO securities settlement to reduce market and liquidity risk if a key bank fails to settle. - Strengthen arrangements in NICS to reduce liquidity pressures (consider shifting larger/time-critical corporate payments to NBO; introduce more settlement cycles). - Facilitate collateralization of interbank exposures and continue counterparty risk surveys. ### Stress testing — banks and insurers (selected numeric outcomes) - Coverage and approach - Stress tests covered eight banks, three life insurance companies and three non-life companies (covering some 66 percent, 86 percent, and 61 percent of total sectoral assets respectively). - Two analyses: top-down by Norges Bank and bank-by-bank analyses by selected banks. - Banks — baseline and scenario CAR outcomes (initial CAR: 11.8 percent) - System-level CAR would decline to some 11 percent after one year and to about 9 percent after three years (bank-by-bank analysis). - Top-down regression results: CAR of 10.9 percent after one year and 8 percent after three years for the terms-of-trade decline / depreciation scenario. - Worst individual bank outcome in severe scenario: CAR declines to 5 percent over three years. - Single-factor shock outcomes (Initial condition 11.8 percent): - Interest rate (Including banking book risk): +500 bps → 11.6; -100 bps → 11.9. - Equity (trading book): +40% → 11.9; -40% → 11.8. - Exchange rate (trading book): +20% → 11.8; -20% → 11.8. - Credit risk — House prices -25% → 11.7. - Domestic inflation crisis: Over 1 year → 11.2; Over 3 years → 9.8. - Domestic inflation crisis (Top-down): Over 1 year → 11.5; Over 3 years → 10.2. - Terms of Trade crisis: Over 1 year → 11.0; Over 3 years → 9.1. - Terms of Trade crisis (Top-Down): Over 1 year → 10.9; Over 3 years → 8.0. - Note: nominal house prices decline over three scenario years amounts to over 40 percent; 1988–1992 real house price decline ~1/3. - Insurance stress-test outcomes - Life insurance: - Initial solvency ratio: 157.6. - Equity – 40% → Change in solvency ratio: -119.0 (exposure 14). - Interest rate +500 bps → Change: -65.0 (exposure 29). - Property -25% → Change: -45.0 (exposure 9). - Increased provisions → Change: -42.0 (exposure 4). - One life company loses all buffer capital and violates capital adequacy requirement (unadjusted). - Non-life insurance: - Initial solvency ratio: 338.7. - Equity – 40% → Change: -25.0 (exposure 11). - Interest rate +500 bps → Change: -27.0 (exposure 54). - Increased provisions scenario → Change: -95.0 (exposure 34). - Caveats: tests exclude marking-to-market of held-to-maturity bond portfolio and other mitigating buffers (fluctuation reserves, part of profit to date, reduced bonuses). ### Multi-variate macro scenarios — selected quantitative outcomes - Scenario 1. Domestic wage inflation and interest rate increase (NB raises key rate by 5 percentage points in 2 years) - Real GDP (% change): 2005 2.4 (-0.8); 2006 1.6 (-1.2); 2007 1.9 (-0.1). - Real household consumption: 2005 2.9 (-1.7); 2006 0.6 (-3.3); 2007 0.0 (-2.6). - Unemployment rate (level): 2005 4.5 (0.4); 2006 4.9 (1.1); 2007 5.0 (1.2). - Consumer prices1: 2005 1.8 (0.4); 2006 2.2 (0.5); 2007 2.7 (0.5). - Interest rate (level)2: 2005 5.3 (3.0); 2006 6.9 (3.7); 2007 6.2 (2.2). - House prices: 2005 -6.7 (-10.2); 2006 -6.4 (-8.3); 2007 2.8 (-0.3). - Notes: 1 Adjusted for tax changes and excluding energy prices. 2 3-month money market interest rate. - Scenario 2. Terms of trade deterioration (oil price halve; NOK depreciates by 20 percent) - Real GDP: 2005 -0.3 (-3.5); 2006 -0.7 (-3.5); 2007 2.4 (0.4). - Real household consumption: 2005 0.4 (-4.2); 2006 -2.6 (-6.5); 2007 -2.2 (-4.8). - Unemployment rate (level): 2005 6.0 (1.9); 2006 7.7 (3.9); 2007 7.8 (4.0). - Consumer prices1: 2005 1.8 (0.4); 2006 2.8 (1.1); 2007 2.5 (0.3). - Interest rate (level)2: 2005 7.3 (5.0); 2006 5.4 (2.2); 2007 3.1 (-0.9). - House prices: 2005 -20.2 (-23.7); 2006 -14.7 (-16.6); 2007 -2.1 (-5.2). - From 2004 to 2007, fall in house prices is 33 percent. ### Supervision, crisis arrangements, and regulatory recommendations - Supervision and legal framework - Overall supervision active, effective, and closely in line with EU norms; FSAN competent with sound integrity. - Recommended refinements: - Further strengthen de jure operational autonomy of FSAN (increase delegated powers from MoF for licensing, prudential regulations, supervisory decisions). - Make regulations more explicit on connected lending, treatment of insiders, and enforcement measures. - Complete development of risk management guidelines (including liquidity and market risks). - Crisis management and safety nets - Crisis arrangements generally well developed; further work needed for cross-border conglomerates and the largest bank (DNB-NOR; roughly 1/3 government ownership). - Deposit guarantee arrangement: very generous by regional and European standards (coverage equivalent to ca € 230,000 versus EU/EEA minimum of € 20,000); suggested systematic review of scheme (coverage levels, pricing, risk sharing, competitive neutrality). - Recommendation: continue work with Nordic authorities on cross-border crisis management and last-resort lending frameworks; ensure coordinated domestic contingency plans for major problem at largest partly state-owned bank. - Preferable longer-term policy: divestiture of DNB-NOR; interim entrenchment of commercial autonomy via law, regulation, or clear public statement. - Coordination for financial stability - Formalize coordination between FSAN, MoF, and NB (more regular senior-level meetings; consider formal tripartite MoU on roles and responsibilities). ### Payments system assessment — compliance and improvements - NBO RTGS system - Complies in full with CPSS Core Principles for Systemically Important Payment Systems; system features: queuing, optimization, unlimited intraday credit against broad collateral, short queuing times. - Access rules clear and nondiscriminatory; cost recovery almost achieved in 2005 and expected to be fully achieved next year (relative to report timing). - Recommended actions include: publish rules and regulations on Norges Bank website; require legal opinions from banks outside EEA applying for access; formalize regular monitoring that NBO complies with Core Principles. - NICS and contingency - NICS processes 27% of payments by value; contingency vulnerability: secondary NICS site may not cope with a wide area disaster—recommend review and upgrade. - Consider shifting larger and time-critical corporate client-to-client payments from NICS Retail to NBO and/or more settlement cycles in NICS Retail. ### Selected policy recommendations (Box 1 — Main recommendations) - Short-term stability-related - Monitor household debt and housing market; examine bank exposures concentrated in vulnerable household sub-groups. - Given reduced mortgage risk weights under Basel II, consider additional capital under “Pillar 2”. - Monitor spillovers from two-tier payments arrangements; increase collateralization of interbank exposures. - Reduce market and liquidity risk in VPO securities settlement if a key bank fails to settle. - Examine moving more payments from NICS Retail to NBO and/or introduce more settlement cycles. - Continue Nordic cooperation on cross-border crisis management; ensure contingency plans for largest partly state-owned bank. - Formalize high-level meetings between FSAN, MoF and NB; consider tripartite financial stability MoU. - Structural and longer-term - Reexamine deposit guarantee arrangements for international comparability. - Examine phasing out clearing of medium and smaller interbank payments in NICS SWIFT-net. - Review continued desirability of state ownership in DNB-NOR; in interim entrench commercial autonomy and accountability. - Supervisory refinements and technical measures - Increase powers delegated to FSAN for licensing and supervisory decisions. - Strengthen regulations on connected lending, insiders, and enforcement. - Complete risk management guidelines for various risks. - Formalize and publish supervisory requirements for payments and securities settlement systems and monitor NBO compliance. *Italic: IMF mission report — Article IV consultation (March 2005).* ### 2005. The findings were further discussed with the Norwegian authorities during the Article IV consultation ### _cr05200 - 2005. The findings were further discussed with the Norwegian authorities during the Article IV consultation ### Mission composition and context - Article IV consultation mission in March 2005. - Team: Mark Swinburne (mission chief), Thordur Olafsson (deputy mission chief), Ritu Basu, Nigel Davies, Jan Woltjer, Virginia La Torre (all IMF/MFD); Etibar Jafarov (IMF/EUR); Peter Pfund (formerly Swiss Federal Office of Private Insurance); Saul J. Carpio (U.S. OCC); Jacob Hostrup Andersen (Danish FSA). - FSAPs assess the stability of the financial system as a whole and do not cover risks specific to individual institutions such as asset quality, operational or legal risks, or fraud. ### Executive summary — overall assessment - Norway’s financial system appears sound, well managed, and competitive; short-term vulnerabilities appear low overall. - Contributing factors: - Improved macroeconomic conditions since mid-2003. - Historically low interest rates. - Generally prudent and transparent frameworks for monetary, fiscal, and financial stability policies. - Existence of the Government Petroleum Fund (GPF) providing significant insulation against sharp movements in oil prices. - Financial sector regulation closely in line with EU norms due to EEA participation. - Principal medium- to long-term risk: rising household debt levels and associated house price inflation. - Authorities have been proactive: among the first countries to construct and publish financial stability analyses. ### Main findings (FSAP) - Banks - Norwegian banks generally have sound capital positions, strengthened risk management processes, and improving profitability. - Stress testing confirmed that, overall, the larger banks should be able to absorb fairly comfortably the credit quality deterioration that would follow from large but plausible shocks to key macro variables. - Market risks for banks appear minor. - If household debt continues growing rapidly, the system may become more vulnerable to substantial shocks to interest rates, household income/employment, or house prices. - Debt burden and household assets are unevenly distributed, with vulnerabilities more concentrated among younger, lower income groups. - Indirect effects via reduced household demand on the corporate sector may be more important than direct household mortgage defaults. - Insurance and pensions - Life insurance companies and pension funds remain susceptible to market risks despite recent rebuilding of balance sheets from global equity price movements. - The sector faces longer-term challenges from low interest rates and historical reliance on guaranteed-return products. - Non-life insurance has clearly improved its overall position over the last couple of years. - Markets, liquidity, and contagion - Some system features could cause contagion and systemic risk in extreme circumstances and need careful monitoring and further risk reduction measures. - Priority: implement stronger risk management measures in the securities settlement system (VPO) to reduce market and liquidity risk if a key bank fails to settle. - The smaller-value payments system would benefit from stronger arrangements to reduce liquidity pressures. - Continued monitoring of potential contagion risks through cross-sectoral and cross-border ownership linkages is needed, although direct inter-institutional exposures through markets appear moderate overall. - More could be done to facilitate collateralization of interbank exposures. - Supervision and crisis arrangements - Overall supervision of financial institutions in Norway is active and effective and closely in line with EU norms. - Desirable refinements: - Further strengthen the de jure operational autonomy of the supervisory agency in a few respects. - Specify requirements or guidelines in a few areas (e.g., connected lending, treatment of insiders, enforcement measures). - Formalize payments system oversight and make key details more public. - Crisis management arrangements are generally well developed, but more work is needed: - Regionally for cross-border conglomerates, especially given the prospect of a major regional bank converting subsidiaries into branches. - Locally for the largest individual bank (DNB-NOR), taking account of its roughly 1/3 government ownership. - Review parameters of the deposit guarantee arrangement (which has very generous coverage limits by regional and European standards) and government ownership stake in DNB-NOR in due course. ### Box 1 — Main recommendations (selected) - Key short-term stability-related recommendations - Continue carefully monitoring the evolution of household debt and the housing market; examine whether banks have concentrations of exposures to more vulnerable sub-groups of household borrowers. - Given the reduced risk weighting of mortgages under Basel II, carefully consider whether additional capital requirements for banks should be required under “Pillar 2”. - Monitor spillovers from two-tier payments arrangements; examine scope for increasing use of collateral in interbank market exposures. - In the securities settlement system, ensure measures to reduce market and liquidity risk in VPO in the event of a key bank failing to settle. - In the retail payments system, examine scope for shifting more payments from NICS Retail to the NBO system, and/or introducing more settlement cycles in NICS Retail during the day. - Continue work with Nordic authorities on evolving cross-border crisis management and last resort lending frameworks; ensure coordinated domestic contingency plans for a major problem at the largest, partly state-owned bank. - Formalize more regular high-level meetings between FSAN, MoF and NB on financial stability issues; consider establishing a formal tripartite financial stability MoU on respective roles and responsibilities. - Key structural and longer-term recommendations - Reexamine key aspects of the deposit guarantee arrangements to achieve greater international comparability in coverage levels. - Examine whether clearing of medium and smaller interbank payments in NICS SWIFT-net could be phased out. - Review continued desirability of state ownership in DNB-NOR; in the interim, consider entrenching appropriate commercial autonomy and accountability for the bank through clear legal, regulatory, or public policy statements. - Refinements to supervisory arrangements and other technical recommendations - Increase level of powers delegated to FSAN for licensing, prudential regulations, and supervisory decisions. - Strengthen and make more explicit regulations relating to connected lending, treatment of insiders, and enforcement measures. - Complete development of risk management guidelines for various risks. - Formalize and publish supervisory requirements and standards for payments and securities settlement systems; formalize monitoring in NB’s Payment System Department of NBO’s compliance with standards. - Further strengthen NB risk management arrangements in relation to collateral accepted from banks. ### Potential sources of risk — macroeconomic and sectoral notes - System structure and exposures - Norwegian financial system is relatively small and relatively concentrated, but competition is active and consolidation is continuing. - System is generally domestically oriented; exposure to foreign risk factors arises more from Norway’s open economy than direct exposures to foreign customers. - Foreign (especially Nordic) ownership has increased significantly and is relatively high by regional standards. - Sector dominated by conglomerates that are relatively small compared to other European countries; ownership and trading linkages are varied. - Macroeconomic environment (paragraphs 5–6) - Macro-economic conditions significantly improved since mid-2003; favorable near-term financial stability outlook. - Monetary policy rapidly eased from late-2002; previous exchange rate appreciation reversed. - Improving world economy and high oil prices stimulating growth and underpinning bank credit quality. - Credit risk is the main source of risk for Norwegian banks. - Credit to mainland Norway rose above 170 percent of mainland GDP by end 2004, about 8 percentage points higher than the previous peak level reached during the banking crisis in the late 80s-early 90s. - Largest exposures: households (mostly mortgages), property management, shipping, services, trade, manufacturing. - Potential risks arise from significant declines in property prices and weakening income or competitiveness of the enterprise sector. - Historically low interest rates have reduced short-term credit risks but may contribute to risk build-up over the medium and long term. _Italic: IMF mission report — Article IV consultation (March 2005)._ ### 7. External factors impinge on Norwegian banks’ credit risk mainly indirectly, ### _cr05200 - 7. External factors impinge on Norwegian banks’ credit risk mainly indirectly, ### External risk channels and macro-financial context - External risk factors that materially affect Norway are: adverse developments in the global economy, interest rates, and stock prices, as well as substantial changes in oil and some other commodity prices. - Norway is the third largest exporter of oil and invests most oil revenues in foreign assets through the GPF. The GPF helps insulate the economy and the financial sector from oil-related boom-bust cycles and sharp exchange rate fluctuations, but does not provide complete insulation (channels include activity in oil-related industries, confidence effects, some fiscal injections, and potential “Dutch disease” effects). - Financial markets are open, with energy products dominating total exports. ### Financial system structure and market shares - Banks are the largest financial market intermediaries by far in Norway, followed by life insurance. - Financial system structure (percent shares, December 2004 snapshot elements shown): - Banks: 56.2% (2003), 53.8% (1999) of total financial sector assets in the provided panels. - Life insurance: 16% (2003), 17% (1999). - Mortgage companies, securities funds, state lending institutions: smaller shares as shown in the source figures. - Banking sector foreign presence (share in total banking sector assets): - 1999: Foreign Subsidiaries 5%, Foreign Branches 6%, Other Banks 89%. - 2004: Other Banks 72%, Foreign Branches 12%, Foreign Subsidiaries 16%. - Market concentration: - Asset share of top 10 banks: DnB NOR large market share (38.5% in Jun 2004), Nordea around 12.9% (Jun 2004); top-two banks continue to hold large market share. - Conglomerate structure allows earnings and risk diversification but creates potential for cross-sectoral contagion. Example group shares (selected): - DnB NOR: Banks 38.8, Finance & Mortg Companies 7.6, Life Insurance 32.9, Non-Life Insurance 29.3, Total group* 32.6 (percent of total assets columns as shown). - Total financial groups: Banks 71.6, Finance & Mortg Companies 14.0, Life Insurance 67.4, Non-Life Insurance 36.9, Total group* 60.6. - Foreign branches in Norway: 9.6 (banks), 8.4 (finance & mortg), 29.3 (non-life, percent of relevant market). - Net interest income and margins have declined (figures show net interest income as percent of average total assets and regional interest margin comparisons). ### Major counterparties — Households - Households account for about 70 percent of gross lending, up from about 60 percent in the early 1990s. - About 80 percent of household loans are mortgages. - About 85 percent of household loans carry floating interest rates (only Finland has a higher ratio in the region). - The share of new mortgages with high loan-to-value (LTV) ratios increased since 2002, but appears to have dropped slightly in 2004 and is lower on average than in several other countries. - Debt and interest burden dynamics and vulnerabilities: - Rising ratio of household debt to disposable income is not an immediate vulnerability given historically low interest rates. - The debt ratio is expected to soon exceed the levels of the early 90’s banking crisis. - Households’ interest burden has declined in recent years and is significantly lower than crisis period levels. - Aggregate household wealth and financial assets have been growing strongly and still exceed debt by a reasonable margin (Norges Bank panels). - House prices are still increasing at an annual rate of around 10 percent (Figure 3). - FSAN analysis: an increase in interest rates to the levels of 2001 would increase the share of loans for which the interest burden is more than 20 percent of income from 11 percent of total loans to about 56 percent. - Debt and assets are unevenly distributed; younger groups with low and middle incomes likely to be most affected. - Policy/research recommendation from mission: further examination of whether important banks have concentration of exposures to more vulnerable household groups. ### Major counterparties — Enterprises - Enterprise borrowing remains an important source of risk despite declining exposure. - Recent trends: - Enterprise debt and interest burden declined in recent years as corporate borrowing slowed due to weak investment demand. - Enterprise profitability improved strongly after mid-2003; credit to enterprises began to pick up from mid-2004 with improving economic prospects. - Sectoral vulnerabilities: - Property management, fishery and fish farming sectors, and shipbuilding are considered more risky due to inherent volatility; exposures can be substantial in some individual, smaller banks. - Commercial property exposures are larger; sector had been weak and only recently started to improve. - Interaction channel: If household debt and the housing market produce problems, the larger effect on banks would likely materialize through enterprise-sector exposures because households would likely reduce consumption before defaulting on housing loans. - Historical note: During the last banking crisis the enterprise sector made the largest contribution to banks’ total loan losses, while household credit deterioration was less marked. ### Banks — strengths, vulnerabilities, and risk management - Earnings and asset quality: - Improved bank earnings in 2003 and 2004, driven by a reduction in loan losses to very low levels. - Non-performing loans (NPLs) are low at about 1.3 percent of gross lending. - Ratio of NPLs net of reserves to Tier I capital is about 11-12 percent for all definitions of bad loans and reserves. - Overall capital adequacy ratio has been quite stable at a solid 12 percent. - Market/funding/exposure characteristics: - Direct market risk exposures are relatively small for banks. - Funding and liquidity risks are relatively small overall, though liquidity has been more challenging for small banks. - There is a relatively high level of funding through local and foreign money and capital markets; currency risks are generally well hedged. - Foreign currency lending is fairly static at around 10 percent of lending. - Structural issues: - Many banks are organized as parts of wider financial groups (including mortgage companies, finance companies, securities funds, life and non-life insurance), which in normal times aids diversification but could increase inter-market contagion and moral hazard in extreme situations. - The banking system is relatively concentrated; DNB-NOR is a very substantial market participant and acts as settlement bank for many smaller banks. - Risk management improvements and challenges: - Risk management has strengthened considerably over the last decade. - Property lending now includes more careful assessment of likely income streams. - Standard credit assessment tool for mortgage lending tests effect of a 500 basis point increase in the mortgage interest rate (varies by size of bank). - Several banks have sophisticated internal risk management systems. - Anticipation of lower regulatory capital under Basel II for mortgage exposures may have contributed to strong mortgage growth; FSAN will need to consider whether Pillar 2 additional capital requirements are needed to offset reduced risk weights on mortgages. - Pending market developments: proposals to introduce mortgage bonds (“covered bonds”) and other forms of securitization should help meet future funding challenges. - Peer comparison (Bankscope 2003 table excerpts as presented): - Tier 1 Capital /Asset: 6.0 6.0 5.0 - ROAA: 0.8 0.8 0.5 - Interest Income/Total Revenue: 76.6 76.6 75.1 - Growth rate of Interest Income: -13.3 7.1 0.0 - Net Interest Earnings/Average Asset: 2.1 1.8 1.4 - Concentration (Top 5 banks' asset/total banking sector asset): 64.9 77.7 44.5 - Net Loans/Deposit: 134.4 86.9 78.6 - Liquid asset/customer and short term funding: 20.3 39.0 35.5 ### Insurance and pensions — vulnerabilities and constraints - Life insurance and pension funds: - Life insurance sector dominated by private pension products; 95 percent carry a guaranteed rate of return to policyholders. - Principal vulnerabilities stem from the obligation to achieve guaranteed returns in local currency for the duration of long-lived policies while covering actuarial risks and administrative costs in an environment where higher returns are more difficult to achieve consistently. - Market structure and asset-liability mismatches: - Norway does not have an extensive capital market and there appears to be a shortage of longer-term NOK investment opportunities, creating asset-liability mismatches. - This shortage forces insurers to look abroad for suitable assets and to hedge additional currency exposure. - Prudential regulation limits unhedged foreign currency exposure to 20 percent of the underlying asset or liability; the industry appears to be at this limit. - The sector remains susceptible to low interest rates and other market risks, especially equity prices and property prices. - Supervisory and policy implications: - There is a premium on sound risk management by life insurance institutions and effective oversight by supervisors. - A range of pension system reforms are pending (discussed elsewhere in the source). ### Stress testing and supervisory considerations - Stress testing is mentioned as part of the supervisory and analytical toolkit (section heading appears: “Stress Testing”), indicating use in assessing vulnerabilities (no specific stress-test scenarios or quantitative results provided in the supplied content). - Supervisory focus points arising from the analysis include monitoring household mortgage growth and LTV distributions, concentrations of exposure to vulnerable household groups, bank preparedness for Basel II risk-weight changes, cross-sector contagion risks stemming from conglomerate structures, and life insurers’ currency and duration mismatches. *Source: IMF staff chapter titled "7. External factors impinge on Norwegian banks’ credit risk mainly indirectly," from the provided PDF content.* ### 16. The stress tests indicated that banks are quite resilient overall, even in the face ### 16. The stress tests indicated that banks are quite resilient overall, even in the face ### Stress testing results for banks - Overall assessment: - Banks are “quite resilient overall” even under a particularly severe scenario involving significant terms of trade deterioration and exchange rate depreciation, coupled with a significant rise in domestic interest rates and a substantial decline in house prices. - Baseline capital adequacy ratio (CAR): 11.8 percent. - Bank-by-bank stress testing suggests the system-level CAR would decline to some 11 percent after one year and to about 9 percent after three years when evaluated against current capital stock. - The top-down regression gave broadly similar results: overall CAR of 10.9 percent after one year for the terms-of-trade decline / depreciation scenario, and 8 percent after three years. - Worst individual bank outcome in the severe scenario: CAR declines to 5 percent over three years. - Note: comparisons against baseline capital/solvency abstract from the fact that some losses would be absorbed through reduced profits rather than reduced capital. - Sensitivities and single-factor shocks: - Banks’ sensitivity to credit risk >> sensitivity to market risk, reflecting the importance of the banking book vis-à-vis trading activities. - The most adverse single-factor shock is an upward shift in the interest rate yield curve (+500 bps), but even this shock does not have an appreciable impact on banks’ CAR on average. - In 4 of 8 cases there were significant offsetting derivative positions rendering interest rate effects largely neutral. - Direct equity and foreign exchange risk on the trading book were limited. - Large share of floating rate loans transfers direct interest rate risk from banks to households. - Scenario-specific CAR outcomes (Initial condition 11.8 percent): - Interest rate (Including banking book risk): +500 bps → 11.6; -100 bps → 11.9 - Equity (trading book): +40% → 11.9; -40% → 11.8 - Exchange rate (trading book): +20% → 11.8; -20% → 11.8 - Credit risk — House prices (partial credit risk) -25% → 11.7 - Domestic inflation crisis: - Over 1 year → 11.2 - Over 3 years → 9.8 - Domestic inflation crisis (Top-down): - Over 1 year → 11.5 - Over 3 years → 10.2 - Terms of Trade crisis: - Over 1 year → 11.0 - Over 3 years → 9.1 - Terms of Trade crisis (Top-Down): - Over 1 year → 10.9 - Over 3 years → 8.0 - Additional scenario context: - The decline in nominal house prices over the three scenario years amounts to over 40 percent, and is higher still relative to the baseline scenario. - By comparison, house prices declined by about 1/3 in real terms between 1988 and 1992. ### Stress testing results for insurance companies - Life insurance companies: - Initial solvency ratio: 157.6. - Most affected by equity shock: Equity – 40% → Change in solvency ratio: -119.0 (exposure 14). - Interest rate +500 bps → Change: -65.0 (exposure 29). - Exchange rate +20% → Change: -5.0. - Property -25% → Change: -45.0 (exposure 9). - Increased provisions → Change: -42.0 (exposure 4). - One company loses all buffer capital and violates the capital adequacy requirement (unadjusted for reductions in risk weighted assets). - Life companies appear largely hedged against exchange rate shocks. - Non-life insurance companies: - Initial solvency ratio: 338.7. - Equity – 40% → Change: -25.0 (exposure 11). - Interest rate +500 bps → Change: -27.0 (exposure 54). - Exchange rate +20% → Change: 0.0. - Property -25% → Change: -16.0 (exposure 5). - Increased provisions (15 percent increase in general provisions combined with 20 percent increase in workers compensation and motor liability provisions) → Change: -95.0 (exposure 34). - Non-life sensitivity concentrated on provisions due to a 34 percent exposure vis-à-vis total liabilities. - Interest risk mitigated by lower duration of interest-sensitive assets relative to life companies. - Insurance sector caveats and mitigating factors excluded from tests: - Results exclude marking-to-market of held-to-maturity bond portfolio (33 (4) percent life (non-life) company assets), which could exacerbate interest rate risk if marked to market. - Decline in domestic and international interest rates since acquisition of this portfolio (average acquisition yield 5.7 percent) has led to mitigating hidden reserves not included. - Results exclude fluctuation reserves, supplementary provisions, the part of profit to date not included in capital (only 50 percent included by regulation), and reduced bonuses for life companies; for non-life, excluded are profit to date not included in capital and fluctuation provision in excess of the minimum requirement. ### Markets and systemic liquidity arrangements - Money and FX markets: - Small but relatively well-functioning and adequately liquid in normal times; no instances of significant disturbances in recent years. - Foreign exchange settlement risks materially reduced since 2003 through Norway joining the Continuous Linked Settlement (CLS) system. - About 10-11 market players quote firm FX prices (not a formalized primary dealer system). - Short-term interbank money market is less active; quotations generally indicative rather than firm; a few large players dominate. - No signs of monopolistic behavior; participants distribute liquidity with limited recourse to central bank facilities. - Trading in FX-related and interest rate derivatives is active; surveys indicate markets are liquid. - Counterparty and collateralization issues: - Uncollateralized exposures in the money market are relatively limited but frequent and require continued close monitoring due to contagion risk potential. - 2001–02 survey of counterparty exposures indicated few banks have uncollateralized interbank exposures that would cause significant problems in case of counterparty failure. - Recommendations: - Authorities should examine ways to further encourage collateralization of interbank exposures. - Continue counterparty risk surveys and publish aggregated results. - Central bank facilities and collateral: - Banks maintain a large share of excess reserves with the central bank in its overnight facility remunerated at the central bank’s sight deposit rate. - Banks hold substantial collateral usable for intraday or longer credit from NB; in emergencies this collateral is judged adequately liquid. - NB has used collateralized loans effectively to align short-term market rates with its sight deposit rate. - Recommendations on collateral and monetary operations: - Further controls on securities accepted as collateral are advisable despite NB’s close monitoring. - Specific suggested measures: - Implement planned reduction of bank bonds as collateral from the 50 percent limit to 35 percent. - Make requirements for domestic and foreign bonds similar. - Introduce a maximum exposure limit to a single issuer. - Liquidity requirement: - Banks are not subject to a reserve requirement, but there is a 6 percent liquid asset requirement. - The 6 percent requirement is described as outdated, probably discouraging liquidity management in smaller banks, and is no longer binding overall (though it may be for some individual banks). - Recommendation: replace the quantitative liquid asset requirement with more qualitative prudential guidelines for liquidity risk management being developed. ### Payments and securities settlement infrastructure - Payments infrastructure: - Systemically important RTGS system, NBO, complies in full with the international standard. - NICS system (smaller interbank and retail payments) accounts for some 28 percent of payments by value and is not considered systemically important but is quite large. - Liquidity risks in NICS: need stronger arrangements to reduce liquidity pressures if the participant with the largest obligation cannot settle. - Recommendations: - Examine shifting larger and time-critical corporate client-to-client payments to NBO. - Consider more settlement cycles during the day. - Over time, review whether separate netting of interbank payments in NICS (SWIFT-net) is still efficient and whether reducing the minimum size for gross settlement eligibility could eliminate separate netting. - Tiered settlement structure and contagion risks: - Around 120 smaller banks (“level 2 banks”) settle indirectly through settlement service providers (direct clearers) with accounts at NB. - Largest bank, DNB-NOR, accounts for almost 40% of the banking market. - Tiered arrangement is voluntary and does not limit competition, but a failure at a settlement service provider could spill over into liquidity problems for many smaller banks. - Recommendation: authorities should continue to monitor spillover risk from settlement service providers to “level 2” banks. - Partial mitigation: most small banks already have an account at NB as a contingency to re-route payments if their settlement agent fails. - Securities clearing and settlement: - Tiered securities settlement structure lacks risk management measures in the event a bank is unable to settle its position. - Guarantees exist from settlement banks to protect against broker default, but no measures exist for a bank failing to settle. - Concentrated payment flows imply a default of the largest participant could cause substantial non-settlements and knock-on effects. - Recommendation: ensure measures to reduce market and liquidity risk in securities settlement—e.g., facilitate transfer of participants’ positions in a failing bank to another settlement agent. - Oversight: - Oversight of payments and securities settlement systems is generally sound but could be strengthened by formalizing and publishing supervisory requirements and standards and by regular monitoring of NBO’s compliance with Core Principles by the Payment System Department. - Note: Payment System Department is not involved in operation of NBO but oversees payment systems outside the central bank. ### Corporate governance, accounting, auditing, and AML/CFT - Corporate governance, accounting and auditing: - Regime is sound, with provisions in primary legislation and subsidiary regulations and a Corporate Governance Code adopted by the Oslo Stock Exchange for traded entities. - Supervision for financial services companies includes on-site inspection, external audit, internal audit, and for insurance companies a control committee. - Accounting, auditing and actuarial standards and professions are well developed and conform with international standards; accountants and auditors licensed and supervised by FSAN. - Continued vigilance required—one recent case demonstrated risks. - AML/CFT: - Norway’s observance of FATF Principles for AML/CFT is being assessed by FATF according to the agreed methodology approved by the Boards of the Fund and the Bank. - Field work completed and the ROSC from the FATF assessment will be circulated to the Board once final. - Staff will provide a short update to the Board prior to the Board meeting on the status of the FATF assessment including, if available, a short summary of FATF findings. ### Strategic risks and structural issues - Pensions reform, capital markets, and long-term implications: - Recent/pending legislation aims to: - Facilitate movement away from guaranteed rate defined benefit (DB) private pension schemes. - Allow more options for risk-sharing between insurers and policyholders and reduce market risk taken by insurance companies. - Require more transparency in premium-setting, including premium related to the guaranteed return. - Proposal for mandatory occupational pensions for the entire workforce, to be supplied mainly by life insurers. - Some 57 percent of the workforce currently does not contribute to occupational pension schemes → potential for substantial increase in longer-term savings. - New mandatory schemes, mainly covering SMEs, would more likely be DC schemes entailing more risk-taking by pension participants. - These measures would tend to reduce risks faced by life insurers and pension funds. - Challenge: relatively thin domestic securities markets will remain a challenge for institutions’ asset-liability management, especially if there is increased demand for DB pensions as a side effect. - Measures to deepen domestic capital markets: - Benefits: support life insurance and pensions sector, help domestic corporates access long-term funding, reduce high dependence on banks as intermediators of savings. - Industry view: government issuance of sufficient long-term bonds could induce a durable liquid market in longer-term NOK instruments, but there is no fiscal or monetary imperative to do so and it would raise other complications. - Recommended steps: - Introduce “covered bonds” and other forms of securitization; authorities should complete the framework for these as soon as possible. - Further privatization of state-owned entities would also help broaden domestic securities markets. ### Competition, entry, and state ownership - Competition and consolidation: - Financial institutions face active competition; supervisors need to monitor implications including likely further consolidation over time. - No substantial artificial barriers to competition in or between sectors; foreign entry into banking has increased significantly and is higher than in many other European countries. - Many smaller savings banks are grouping together; savings banks (mutuals) can demutualize to facilitate acquisition. - State ownership in DNB-NOR and associated risks: - Government holds roughly 1/3 of the shares in DNB-NOR and has distanced itself from day-to-day management decisions. - State purchases were undertaken transparently and market-based when topping up shareholding after dilution in a merger. - Longer-term risks of significant state ownership: - Policy of non-interference could change, with implications for efficient resource allocation and, in extreme cases, bank soundness. - Perception that the bank is “too big to fail” may heighten moral hazard risks or give DNB-NOR an unwarranted competitive advantage in ratings or funding costs. - Less active “market for corporate control” might weaken governance or competitiveness over time. - State ownership does not contribute to broadening domestic securities markets, at a time when such broadening would be beneficial. *Italic: Source — IMF staff chapter content as provided in the supplied PDF excerpt.* ### 33. The above issues should be carefully considered in the next stock-take of the ### 33. The above issues should be carefully considered in the next stock-take of the ### Government ownership and DNB-NOR - Preferable longer-term policy response: divestiture of DNB-NOR. - Interim measures to reduce (real or perceived) risk of future policy reversal on the bank’s commercial autonomy: - Consider arrangements to further “entrench” commercial autonomy for DNB-NOR. - Ameliorate potential side-effects of state ownership where possible. - Options include a law, regulation or at least a clear, public statement quite specifically defining the principles behind the government’s day-to-day relationship with the bank. - Note: The Government’s current share gives it a veto over take-overs. ### The financial stability policy framework (overview) - Post-early 1990s crisis: Norway’s financial stability framework strengthened; financial system surveillance developed and geared to identify and assess potential risks and vulnerabilities. - NB’s and FSAN’s financial stability-related publications described as exemplary; increased emphasis on transparency in the financial policy framework. - Monetary policy conducted transparently aided by recent institutional reforms; NB’s role as government’s agent for the GPF is transparent. - Market commentary: need to publicly explain further the role of the exchange rate in NB’s inflation targeting regime. - Footnote observation: This has contributed to the absence of significant disorderly conditions in exchange markets, under Norway’s floating exchange rate regime of recent years. ### Regulation and supervision — recommended refinements - Aim: reinforce strong banking supervision arrangements and FSAN’s de facto operational independence; help ensure effective operational independence is maintained as personalities and political conditions evolve. - Recommended delegations from MoF to FSAN: - Increase powers formally delegated by the MoF to the FSAN in respect of initial licensing of institutions (and exchanges), as well as authorization of new activities or acquisitions. - Increase powers formally delegated by the MoF to the FSAN for issuing prudential regulations and supervisory decisions. - Consider mechanisms to reduce the real or perceived scope for undue governmental influence in the appeal process for administrative complaints (e.g., publicly clarifying circumstances when MoF would, or would not, overrule FSAN). - BCP assessment additional suggestions: - Continue to bed down and fully implement the new, more formal internal systems agreed in late 2004 to ensure ethical standards are maintained and seen to be maintained within FSAN. - Make more explicit aspects of regulations on connected lending and the treatment of insiders. - Expand enforcement and incentive tools. - Complete development of risk management guidelines for additional types of risk, including liquidity and market risks. - ICP-related recommendations: - Increase delegated authority for the FSAN. - Ensure careful ongoing oversight of risk management challenges facing the insurance and pensions sector arising from the relative shortage of suitable NOK assets. - Insurance supervisors should introduce, as planned, the EU intermediary directive and the consumer protection regulation covering disputes between clients and intermediaries. - Securities regulation review (brief): - Laws and regulations governing securities markets are comprehensive and modern. - Supervision is robust and conducted coherently by highly qualified FSAN staff; procedures are transparent. ### Coordination for financial stability - Consider formalizing coordination between FSAN, MoF, and NB for normal situations and crisis preparedness: - More regular senior-level meetings on financial stability issues. - A formal tripartite MoU setting out respective roles and responsibilities could be useful for transparency. ### Safety nets, financial conglomerates, and crisis management - Deposit insurance: - Norway’s deposit insurance arrangement is described as very generous by regional and European standards. - Suggestion: conduct a systematic review of the scheme in the fairly near future to ensure it continues to contribute to financial stability and efficiency as the financial sector evolves. - Review should be coordinated with any regional or EU-level review. - Review scope: coverage levels; risk sharing; pricing; competitive neutrality among locally incorporated banks, foreign branches and direct cross-border banking relationships. - Harmonization of coverage levels with other countries, if desirable, should be done carefully and in a phased manner. - Context: The coverage is equivalent to ca € 230,000, compared to the minimum deposit insurance level within the EU/EEA of € 20,000, and is roughly eight times higher than in Sweden. - Nordea proposal implications: - Proposal to convert regional subsidiary banks into branches highlights need to reassess roles in crisis management for locally important branch operations and potential last resort lending. - Raises definition issues of home and host country responsibilities for day-to-day supervision. - Close coordination between Norwegian authorities and Nordic counterparts is needed; process already well underway. - Norges Bank (NB) role: - NB’s general role as lender of last resort appears well defined in the NB’s Act and regulation; provides necessary flexibility. - NB has publicly clarified broad parameters of general emergency lending policies, balancing transparency and a degree of “constructive ambiguity” about specifics. - Key task: continue working with other Nordic central banks to elaborate mechanisms for emergency liquidity support to cross-border financial conglomerates like Nordea. - Existing MoU between Nordic central banks on management of financial crisis in a Nordic bank with activities in two or more Nordic countries needs refocusing to cover the case of Nordea Norway becoming a branch; task is underway. - Crisis management arrangements: - Generally well developed (arrangements, guidelines, checklists), but further elaboration needed for special challenges posed by the largest and most systemically important bank and potential cross-border threats. - Given roughly 1/3 state ownership of DNB-NOR, government role in crisis management needs fuller specification in contingency plans. - Authorities should develop appropriate contingency plans that take account of these special circumstances and address potential cross-border financial threats within large financial conglomerates. ### Annex — Observance of financial sector standards and codes (summary) - Assessments undertaken: Basel Core Principles for Effective Banking Supervision (BCP); IAIS Insurance Core Principles (ICP); Core Principles for Systemically Important Payment Systems (CPSIPS). - BCP and IAIS assessments conducted during mission to Norway from October 14 to 26, 2004; CPSIPS assessment conducted from January 17 to February 3, 2005. - Assessments based on laws, regulations, policies and practices in place at the time; sources included self-assessments, document reviews, interviews with supervisory authorities, meetings with MoF, Norges Bank and other authorities, and meetings with financial sector firms and associations. ### Basel Core Principles — institutional and prudential findings - Market structure and macroprudential overview: - As at mid-2004, there were 141 banks and 8 branches of foreign banks in Norway. - Banks and branches of foreign banks held about 75 percent and 4 percent, respectively, of total domestic loans. - Banks appear well capitalized with a capital adequacy ratio of 12.2% and nonperforming loans have fallen to an historically low level of less than 1% of total loans. - Risk concentrations: - Exposure to cross-sectoral and regional economic developments due to conglomeration structure and significant presence of foreign (Nordic) banks. - Key risk sectors: housing and other property, fisheries and fish farming, and shipping. - Household borrowing for housing identified as the greatest source of potential risks for banks. - Institutional responsibilities: - Responsibility for financial stability shared between Norges Bank, the FSAN, and the Ministry of Finance. - MoF primarily responsible for regulatory framework; Norges Bank responsible for monetary and exchange rate policy, and efficient payment systems and financial markets. - FSAN supervises banking, insurance, pension, equity and other financial services sectors and licenses and regulates accountants and auditors. - Preconditions for effective supervision: - Laws, accounting and transparency practices, and financial sector regulation support effective banking supervision. - Framework for addressing financially distressed institutions in place; vigilance over corporate governance evident. - Government ownership in banking sector has shrunk materially, but retains a large stake on DnB NOR. - As an EEA member, Norway required to implement EU financial services Directives. - Main BCP findings and recommended actions: - Strengths: well-articulated supervisory objectives; adequate legal authority; FSAN competent with sound integrity and capacity to conduct effective bank supervision. - CP-1 (Objectives, Autonomy, Powers, Resources): - Norwegian laws provide clear framework, objectives and responsibilities for bank supervision. - Industry and authorities affirm supervisory decisions are free of undue external interference. - Recommendations: continue transparency of FSAN budgets; fully implement newly agreed measures related to training and reporting; selectively expand licensing and rule-making authority delegated to FSAN; ensure and clarify that FSAN’s safety-and-soundness decisions are not undermined if appealed to MoF. - CPs 2–5 (Licensing and Structure): - Permissible activities and prudential standards for licensing are well established. - Licensing authority rests with the Ministry of Finance, with significant input and recommendation from FSAN. - CPs 6–15 (Prudential Regulations and Requirements): - Prudential regulations and requirements largely in line with Core Principles. - Enhancements suggested for loan loss provisioning, connected lending and country risk management. - CPs 16–20 (Methods of Ongoing Supervision): - FSAN uses off-site and on-site activities; information for monitoring is adequate and timely. - On-site inspection review practices and methods are not sufficiently formulated in an updated on-site inspection manual. - FSAN has initiated a project to develop a more risk-based supervision approach for larger financial institutions. - FSAN should continue to review adequacy of resources in light of rapid industry changes. - CP-21 (Accounting Standard): - FSAN empowered to require financial information and audits; accounting rules in line with EU Directives. - Authorities implementing new EU Regulation adopting international accounting standards. - CP-22 (Remedial Measures): - Ability to issue Orders under Financial Supervision Act (including higher capital ratios and restrictions on credit extension) supports supervisory actions. - Further legally backed tools recommended: Orders to force institutions to arrange good risk management practices; restrict activities of institutions in unsatisfactory condition; empower FSAN to set adequate individual loan loss provisions and reserves as indicated in CP-8. - CPs 23–25 (Cross-Border Banking): - Regulatory framework for consolidated supervision over internationally active financial groups is satisfactory. - Coordination and exchange of information with foreign supervisors is adequate. ### Authorities’ response (summary) - Authorities’ standpoint: - FSAN is an administrative agency acting under general responsibilities of the Ministry of Finance. - FSAN activities managed by an independent board and a director general appointed by the King in Council for periods of 4 and 6 years respectively. - Objective: FSAN to exercise supervisory function independently of government or industry interference. - Decisions by FSAN may be submitted for review by the Ministry of Finance under the general system for administrative complaints. - On delegation of licensing and authorization authority: - Authorities note frequent examination of the issue. - Constitutional system where the minister is responsible to the legislature for financial supervision limits possibilities for excluding ministerial oversight and decisionmaking. - Authorities argue decisions by the Ministry will be based on FSAN recommendations, enhancing transparency. - Administrative decisions are subject to court review; incorrect decisions may be found invalid. - Authorities maintain concern that focus on risk of incorrect decisions at ministry level is unwarranted and that FSAN should remain unpolitical and not be charged with politically sensitive decisionmaking. *Source: IMF staff assessment text as provided in the supplied content unit.* ### 59. The authorities also noted that Norwegian budget procedures have been developed to ### _cr05200 - 59. The authorities also noted that Norwegian budget procedures have been developed to ### Budgetary and institutional arrangements for financial supervision - Norwegian budget procedures enable the Storting (parliament) to establish general spending levels and to prioritise resource allocation based on a comprehensive proposal from the Government. - The budget for financial supervision is part of these procedures, and a relaxation of fiscal discipline is not foreseen. - FSAN is a public sector agency accountable to the Ministry of Finance (MoF) under the Norwegian constitution. - FSAN activities are managed by an independent board and a director general appointed by the King in Council for periods of 4 and 6 years respectively. - Decisions made by FSAN may be submitted for review by the Ministry of Finance under the general system for administrative complaints and review. ### Main findings on supervisory independence, transparency, and governance - The MoF has de jure power to make supervisory decisions and reserves the right to make decisions based on a governmental agenda; no evidence that these arrangements have adversely impinged on FSAN operations was found. - Recommendation theme: greater transparency and autonomy in budgetary and supervisory processes; change to the Board of Directors to balance consumer, regulated community, and supervisor interests; Board should act transparently and be ultimate supervisory decision maker. - Authorities’ view: ministerial oversight is constitutionally rooted; ministerial decisions are based on FSAN recommendations and are considered potentially more transparent than FSAN-only decisions; administrative decisions are subject to court review. ### Recommended actions in the area of banking supervision (Table 1 — selected CP references and actions) - CP-1.2 Independence/Ethics - MOF and the Financial Services Agency of Norway (FSAN) should continue to foster a more transparent process to determine the levels of FSAN’s annual budgets. - Consider establishing more explicit criteria for the composition of FSAN’s Board of Directors with the aim of higher independence through a balance of industry, supervisory and public interest representation. - Initiate periodic training sessions and regular reporting to the FSAN Board of Directors on employees’ and directors’ transactions and activities with regulated entities. - CP-1.3 Legal Framework - Expand FSAN’s licensing and regulation-making authority delegated from the MOF. - MOF should explicitly set a high standard in reviewing cases appealing FSAN supervisory decisions. - CP-8 Loan Loss provisions - FSAN should have explicit authority to increase loan loss provisions to strengthen pro-active measures to address bank weaknesses. - CP-10 Connected Lending - Regulations should explicitly require loans granted to bank insiders be in accordance with the bank’s usual business terms and conditions. - Scope of definition of governing bodies should apply to business exposures with persons related to members of governing bodies by marriage or kinship, and to business exposures with companies in which such persons are members of the board or management. - CP-11 Country Risk - FSAN should be given authority to establish guidelines for effective management of country and transfer risk; regulation should explicitly address reserves against transfer/country risks. - CP-13 Other Risks - FSAN should complete development of risk evaluation guidelines in key risk areas with the broader goal of compiling an effective, up-to-date bank supervision manual. - CP-22 Remedial Measures - Add several remedial tools specifically backed by legal authority, including: - Orders to force financial institutions to arrange good risk management practices in accordance with FSAN provisions; - Orders or explicit restrictions on financial institutions in unsatisfactory condition (withholding approval to open new offices, expand into new products, or acquire new businesses); - Orders to empower FSAN with authority to set adequate individual loan loss provisions (also included in CP-8). ### Insurance sector structure, risks, and supervisory recommendations (IAIS Insurance Core Principles) - Institutional and macroprudential setting - The Norwegian Financial Services sector is concentrated and dominated by conglomerates; conglomerates are small compared to those in other European countries and have mixed ownership and trading linkages via strategic alliances and ownership. - Market concentration, conglomeration and business globalization increase the risk of systemic contagion. - Pensions and life insurance product structure - Pensions products in the Norwegian private insurance sector, whose assets amount to over 90 percent of the life sector total, carry a guaranteed annual return. - Pillar 2 and pillar 3 pension schemes that carry a guarantee constituted 74.9 and 16.8 percent of life insurance funds respectively at September 2003. - Table 2 (Pension schemes as of December 31, 2003 in life insurance companies* and management companies for securities funds) - Type — Number of premium-paying contracts — Life insurance funds (NOK Million) - Defined-benefit pension schemes (DB) 16 264113 400 - Defined-contribution pension schemes ** (DC) 1 857690 - Transferred from DB to DC 127376 - * Municipal pension schemes not included. - ** Of which in management companies: No. of contracts: 87, managed assets: NOK 39 million - Source: Norwegian Financial Services Association. - Market features and product trends - Evident competition in the life and pensions sector; participants keen to provide occupational (Pillar II) pension schemes to the as yet uncovered portion of the working population, which amounts to some 55 percent thereof. - New schemes offered are likely to be defined contribution, where the consumer bears greater risk. - Non-life sector: premium rates appear sufficient to allow an adequate underwriting profit across participants; return on equity is sensitive to capital requirements. - Systemic and prudential issues identified - Predominance of long term pension products and small size of the Norwegian capital market entail currency and duration mismatches in the pension sector. - Insurance sector has higher large exposure limits than the banking sector. - FSAN aware of these issues; remedial actions suggested include design of capital requirements to cover mismatches and large exposures, encouragement of products that pass risk to the consumer, strengthening conduct of business rules, and implementation of a corporate governance code for insurers addressing policyholder interests. - Table 3 (Recommended Actions in the Area of Insurance Supervision — selected items) - Supervisory authority (CP 3) - Consider establishing more explicit criteria for composition of FSAN’s Board of Directors aiming at greater independence through a balance of industry, supervisory and public interest representation. - Such a Board could be the ultimate supervisory decision maker, and greater budgetary autonomy could be delegated to it to improve transparency. - Supervisory process (CP 4) - Codify relevant decision-making criteria, and delegate all decision making rights to FSAN. - Suitability of persons (CP 7) - Implement appropriate “whistleblowing” regulations for insurers where no obligation currently exists for insurers to inform FSAN if a notifiable person ceases to fulfill “fit and proper” requirements. - Investments (CP 21) - Address currency and duration mismatches and higher large exposure limits via a combination of measures including: a capital element specifically measured to cover known mismatches; greater use of products such as DC pensions where risk is borne by the consumer; and strengthening Conduct of Business Principles (ICPs 24, 25, 26) if DC pensions become common market practice. - Consumer protection (CP 25) - Draft regulation to extend the Norwegian Bureau for Insurance Disputes (NBID) coverage to handle disputes between clients and intermediaries should be promulgated, accounting for the likelihood of risk borne by consumers. - Anti-money laundering (CP 28) - The revised FATF recommendations are not currently transposed into Norwegian law because they will be reflected in the Third EU Money Laundering Directive, which is not yet implemented. - If the Directive is not likely to be implemented in the near future, regulations should be introduced in advance to give effect to the FATF recommendations. ### Payments and securities settlement systems — main findings - Scope of assessment - CPSIPS assessment focused on Norges Bank Oppgjønsystem (NBO); also reviewed Norwegian Interbank Clearing System (NICS) and securities settlement systems with emphasis on risk management. - Institutional roles - Main institutions in payment systems policy: Norges Bank, Norwegian Savings Bank Association, Financial Services Association. - Norges Bank roles: (i) operational involvement; (ii) oversight function on payment systems; (iii) catalyst role to induce payment changes and facilitate private sector initiatives. - The two Banking Associations formulate industry policy, set interbank standards, and sustain self-regulation via agreements and rules. - Payment system infrastructure and thresholds - Infrastructure consists of: (i) RTGS for interbank large value payments (NBO); (ii) a netting system for medium and smaller SWIFT or interbank payments; (iii) a multilateral clearing system for retail payments (NICS). - NBO settles all interbank payments above NOK 25 million and is considered a systemically important payment system. - NICS clears interbank payments below NOK 25 million, processes and clears retail payments on a multilateral basis, and offers data communication services for NBO. - Value of retail payments cleared via NICS: NOK 14,409 billion or around 27% of all payments in 2004. - Banking participation statistics - There were 149 banks (including foreign branches) registered in Norway in mid-2004, and 147 active in payments systems as at early 2005. - 121 of the smaller banks use one of the larger banks as their settlement bank. - DnB-NOR and Swedbank Oslo offer settlement services to level 2 banks. - Retail payments efficiency and usage - The infrastructure for retail payment is highly developed and efficient. - In 2003 over 78% of all giro transactions were electronically initiated by customers via ATM terminals, telebanking, the internet, or as direct debit. - Paper-based payment instruments fell to around 5% of all giro transfer orders; use of checks has diminished to negligible proportions. - Fees introduced in 1984 reflect cost differences across instruments; fees cover up to 70% of banks’ operational costs. - Since 2002, use of float is forbidden by law, promoting transparency and reducing processing time. - Prerequisites for effective oversight - Norway fulfills prerequisites for effective payment clearing and settlement systems: strong private sector role, well-established bank cooperation, well-structured Norges Bank–banking sector relationship, sound legal framework, clear default procedures, well-established crisis management, adequate accounting practices, highly automated and secure infrastructure, dispute resolution mechanisms in place. *Source: _cr05200 - 59. The authorities also noted that Norwegian budget procedures have been developed to* ### 78. The system complies with all 10 Core Principles. There were only minor ### _cr05200 - 78. The system complies with all 10 Core Principles. There were only minor ### Overall compliance and system evaluation - The system complies with all 10 Core Principles. There were only minor recommendations that could lead to a further improvement of the existing system and the change-over to a new system. - Full compliance with respect to the Responsibilities of Norges Bank could be reached by: - regularly monitoring the compliance of the existing system, as well as the plans for the new system, and - charging the Payment System Department to oversee the NBO. This department is not involved in the operational process and is already responsible for the oversight of payment systems outside the central bank. ### Legal framework and access - The operations of the NBO-system are embedded in a solid legal framework of laws and contractual arrangements that are complete, reliable and enforceable in all relevant circumstances. - Irrevocability and finality are clearly defined in the law and in the rules of the system and are ensured even in case an insolvency procedure is opened against a participant in the system. - Collateral arrangements in payments and securities settlement systems are fully enforceable. - Recommended legal improvement: - Require a legal opinion from banks outside the European Economic Area that apply to become participant in the system. ### Documentation, transparency, and accessibility - Available documentation and publications of Norges Bank enable participants to understand the system’s impact on each of the financial risks they bear through participating in the NBO-system. - Improvements possible: - Enhance accessibility and the ability to survey the rules and regulations, which are currently spread across several contractual agreements between participants and the system provider. - Enlarge the survey ability and publish the rules and regulation for the system on website of Norges Bank. (Table 4 recommendation under CPs 2-3) ### Risk management, liquidity, and operational reliability - NBO is an RTGS-system with queuing facilities settling in central bank money and offers protection against credit risk. - Liquidity risk management: - Unlimited intraday credit is provided against a broad range of Norwegian and foreign collateral. - Abundant liquidity and an optimization procedure continuously net queued payments; queuing time in NBO is short. - Security and operational reliability: - Norges Bank has an effective security policy, clear objectives for high operational reliability, proactive risk assessment, and appropriate risk-control measures. - Adequate business continuity measures and back-up systems are in place. - Vulnerability concern: - The secondary site of the NICS-system that provides participants of NBO with liquidity management information is not able to cope with a wide area disaster; consider whether this forms a vulnerability of the infrastructure. ### System features, market practicality, and costs - NBO includes standard RTGS features for sending, queuing and inquiry, plus an optimization procedure that promotes throughput and helps solve imminent gridlocks. - NBO provides characteristics of a modern RTGS system, reduces systemic risks, and offers an efficient channel for the execution of monetary policy. - Cost recovery: - Taking into account the public good factor in the system, cost recovery has almost been achieved in 2005, and will be fully achieved next year. - Transaction fees are at an acceptable level compared with systems in other countries. ### Access rules and governance - Access rules for the NBO-system are clear, publicly disclosed, fair and objective; access criteria do not have a restrictive impact on competition. - Governance arrangements are effective, accountable, and transparent; adequate consulting procedures with the banking industry are in place around major decision-making. - Public information: - The public is well informed about the roles of Norges Bank and its objectives in the payments area and about new developments and envisaged changes. - Governance weakness: - No clear assignment of responsibility in Norges Bank for the compliance of the NBO-system with the Core Principles, and no formal procedures are in place to monitor regularly that the system complies with these international standards. - Oversight: - Norges Bank is charged by law with oversight of payment systems and has adequate instruments and resources. - Improvement possible by enhancing transparency of the oversight policy through codifying and working out requirements for different categories of payment systems and system providers. - Norges Bank cooperates closely with Kredittilsynet and participates in international consultation meetings; MoUs with other Nordic central banks exist on exchange of information and crisis management. ### Authorities’ response and next steps - Norges Bank notes IMF and its own evaluation that the NBO RTGS system complies in full with the CPSS Core Principles for Systemically Important Payment Systems and will work to achieve further improvements based on the comments and recommendations. - Norges Bank will cooperate with the banking industry to examine measures to further improve efficiency of NBO. - As licensing authority and overseer of the NICS payment system, Norges Bank has expressed to NICS Operator Office a preference that larger time critical transactions be transferred from net settlement to the NBO RTGS system. - Norges Bank has taken steps for NICS Operator Office to consider the vulnerability of the infrastructure in case of a wide area disaster. - Norges Bank will examine how formal internal procedures can be improved to ensure continuous monitoring of compliance of the central bank’s own system with international standards and will enhance transparency regarding the bank’s oversight responsibility. - In connection with the introduction of the renewed RTGS system (planned for launch in 2006-2007), a more comprehensive overview of information relating to the settlement system will be published. ### Table 4 — Recommended Actions (selected items) - Well-founded legal basis in all relevant jurisdictions (CP 1) - Specify in the rules and regulations that banks from outside the European Economic Area (EEA) when applying for access to the NBO-system, have to provide a legal opinion with respect to possible conflicts of law. - Understanding of the system’s impact on risks; and procedures for the management of risks (CPs 2-3) - Enlarge the survey ability and publish the rules and regulation for the system on website of Norges Bank. - Security and operational reliability; and contingency arrangements (CP 7) - Consider the vulnerability of the infrastructure due to the fact the contingency facilities of the NICS-system could not deal with a wide area disaster. - Practical for the markets and efficient for the economy (CP 8) - Analyze with the banking industry whether the efficiency and practicality of the NBO-system, or the new system that will replace the NBO in 2007, could be enlarged. Within this context it could be studied: - (i) to remove the agreement among banks on coordinated exchanges of transactions between 12.30 pm and 13.30 pm; - (ii) to abolish the netting of interbank payments below NOK 25 million; and - (iii) to use the NBO for time-critical and larger client-to-client payments. - Intensify existing coordination and cooperation between Norges Bank, the NICS-system providers, and all other relevant parties for rescheduling and updating both the NBO-system and the NICS-system. - Responsibility B - The central bank should ensure that the systems it operates comply with the core principles. - Introduce procedures to monitor regularly the present NBO-system and ensure that the plans for the new system comply with the Core Principles. - Responsibility C - The central bank should oversee observance with the core principles by systems it does not operate and it should have the ability to carry out this oversight. - Enhance the transparency of the oversight policy for payment systems by codifying the requirements for the different types of systems and publishing them on the website of Norges Bank. ### Methodological aspects of stress testing in the Norway FSAP - Coverage: - Stress tests covered eight banks, three life insurance companies and three non-life companies that held some 66 percent, 86 percent, and 61 percent, respectively, of total sectoral assets. - Approach: - Choice of scenarios followed Norges Bank simulations using its aggregated inflation forecasting and related loss model for enterprises and households. - Parameters from these scenarios were passed on to banks, which implemented bank-by-bank analyses using their internal models. - Two sets of analysis for banks: a top-down analysis by the central bank and a bank-by-bank analysis by each of the selected 8 banks to cross check aggregate results. ### Single-factor shocks (applied to Banks; Life and non-life Insurance Companies) - Interest rate - +500 bps parallel shift in yield curves - -100 bps parallel shift in yield curves - Equity - +/- 40 percent change in all relevant stock indices - Exchange rate - +/- 20 percent change in NOK vis-à-vis other currencies - House prices (Partial measure of Credit risk) - Banks: -25 percent change in house prices (only partial representation of credit risk) - Insurance: -25 percent change in property prices (only partial representation of credit risk) - Disability Provisions (Insurance) - +50 (for life), +15 or +35(for non-life) percent change in provisions for future disability pensions ### Multi-variate scenarios — Summary and key numeric outcomes Scenario 1. Domestic wage inflation and interest rate increase - Narrative: - NB raises its key interest rate by 5 percentage points in a 2-year time horizon as inflationary expectations rise. NOK appreciates; domestic real GDP growth declines relative to baseline; household consumption and investment weaken; unemployment increases; house prices and stock/commercial prices decline. - Scenario 1. Percentage change from previous year. Deviation from baseline in percentage points (parentheses). - Real GDP: 2005 2.4 (-0.8); 2006 1.6 (-1.2); 2007 1.9 (-0.1) - Real household consumption: 2005 2.9 (-1.7); 2006 0.6 (-3.3); 2007 0.0 (-2.6) - Unemployment rate (level): 2005 4.5 (0.4); 2006 4.9 (1.1); 2007 5.0 (1.2) - Consumer prices1: 2005 1.8 (0.4); 2006 2.2 (0.5); 2007 2.7 (0.5) - Interest rate (level)2: 2005 5.3 (3.0); 2006 6.9 (3.7); 2007 6.2 (2.2) - House prices: 2005 -6.7 (-10.2); 2006 -6.4 (-8.3); 2007 2.8 (-0.3) - Notes: - 1 Adjusted for tax changes and excluding energy prices. - 2 3-month money market interest rate. Scenario 2. Terms of trade deterioration (perhaps due to decline in oil price) - Narrative: - NOK depreciates by 20 percent as oil prices halve. Decline in oil price reduces consumer confidence and affects fiscal policy negatively. NB increases its key rate by 5 percentage points in response. Positive effect from real exchange rate depreciation is dominated by negative effects from consumption and fiscal policy reaction. Household consumption falls strongly; real GDP growth much lower in 2005 and 2006 but picks up in 2007; unemployment increases; household disposable income falls; household debt burden and interest burden increase; house prices fall. From 2004 to 2007, the fall in house prices is 33 percent. - Scenario 2. Percentage change from previous year. Deviation from baseline in percentage points (parentheses). - Real GDP: 2005 -0.3 (-3.5); 2006 -0.7 (-3.5); 2007 2.4 (0.4) - Real household consumption: 2005 0.4 (-4.2); 2006 -2.6 (-6.5); 2007 -2.2 (-4.8) - Unemployment rate (level): 2005 6.0 (1.9); 2006 7.7 (3.9); 2007 7.8 (4.0) - Consumer prices1: 2005 1.8 (0.4); 2006 2.8 (1.1); 2007 2.5 (0.3) - Interest rate (level)2: 2005 7.3 (5.0); 2006 5.4 (2.2); 2007 3.1 (-0.9) - House prices: 2005 -20.2 (-23.7); 2006 -14.7 (-16.6); 2007 -2.1 (-5.2) - Notes: - 1 Adjusted for tax changes and excluding energy prices. - 2 3-month money market interest rate. *Source: IMF staff report content as provided.* ### 47.8 percent in 2002, 31.4 percent in 2003, and 33.7 percent in Q2 of 2004. ### _cr05200 - 47.8 percent in 2002, 31.4 percent in 2003, and 33.7 percent in Q2 of 2004. ### Capital - Regulatory capital/ RWA: - 2002: 12.15 - 2003: 12.36 - 2004: 12.16 - Tier 1 Capital/ RWA: - 2002: 9.60 - 2003: 9.72 - 2004: 9.76 ### Earnings and Profitability - ROAA: - 2002: 0.40 - 2003: 0.58 - 2004: 0.85 - ROAE: - 2002: 6.18 - 2003: 9.61 - 2004: 14.62 - Interest income /Interest income + Operating income: - 2002: 91.79 - 2003: 86.74 - 2004: 82.54 - Net interest earnings/Average asset: - 2002: 2.13 - 2003: 1.90 - 2004: 1.77 - Operating expense/Average asset: - 2002: 1.76 - 2003: 1.63 - 2004: 1.55 ### Asset Quality - Non-performing loan (NPL)/ Gross lending: - 2002: 1.83 - 2003: 1.59 - 2004: 0.97 - Loan loss provision/NPL: - 2002: 29.21 - 2003: 33.12 - 2004: 36.75 - NPL net of loan loss provision /Tier 1 capital: - 2002: 17.12 - 2003: 14.31 - 2004: 8.24 ### Concentration and Loan Composition - Total loans/Total assets: - 2002: 80.48 - 2003: 79.50 - 2004: 81.32 - Mortgages/Total loans: - 2002: 49.22 - 2003: 52.02 - 2004: 55.61 - Non-financial enterprises (incl. unincorporated enterprises/households)/ Total loans: - 2002: 36.57 - 2003: 33.84 - 2004: 32.09 - Foreign currency/Total loans: - 2002: 9.97 - 2003: 10.34 - 2004: 8.37 - Foreign sector/Domestic sector loans: - 2002: 3.89 - 2003: 3.95 - 2004: 3.68 ### Funding and Liquidity - Total deposits/Liability and equity: - 2002: 66.20 - 2003: 62.52 - 2004: 63.00 - Deposits of non-financial sector/Liability and equity: - 2002: 50.95 - 2003: 47.83 - 2004: 49.34 - Deposits from foreign financial institutions/Liability and equity: - 2002: 10.78 - 2003: 10.54 - 2004: 9.78 - Bonds/Liability and equity: - 2002: 13.78 - 2003: 16.29 - 2004: 16.95 - Other liabilities/Liability and equity: - 2002: 6.25 - 2003: 7.90 - 2004: 7.04 - Foreign currency liability and equity/ Total liability and equity: - 2002: 20.78 - 2003: 24.26 - 2004: 23.22 - Foreign borrowing by banks/Liability and equity: - 2002: 13.74 - 2003: 12.89 - 2004: 12.45 - Loans net of provisions/Deposits: - 2002: 119.55 - 2003: 125.21 - 2004: 127.47 - Liquid asset/Short-term liability: - 2002: 56.46 - 2003: 58.91 - 2004: 59.26 ### Memorandum Items - Household debt/ GDP: - 2002: 72.67 - 2003: 77.66 - 2004: ... - Assets of top five banks/Total banking sector asset: - 2002: 58.86 - 2003: 59.63 - 2004: 60.85 ### Insurance Sector (selected indicators) - Life Insurance Companies — Total assets: - 2001: 394 656 - 2002: 414 154 - 2003: 459 188 - 2004: 508 991 - Life Insurance Companies — Bonds held to maturity: - 2001: 72 548 - 2002: 124 673 - 2003: 166 206 - 2004: 165 405 - Life Insurance Companies — Equities and units (current assets): - 2001: 80 127 - 2002: 30 497 - 2003: 55 440 - 2004: 79 812 - Non-life Insurance Companies — Total assets: - 2001: 39 184 - 2002: 40 674 - 2003: 48 745 - 2004: 55 278 - Non-life Insurance Companies — Bonds and money market instr. (total): - 2001: 12 718 - 2002: 22 487 - 2003: 26 148 - 2004: 35 876 - Non-life Insurance Companies — Technical provisions: - 2001: 25 166 - 2002: 28 157 - 2003: 32 062 - 2004: 35 676 *Source: Norges Bank; FSAN.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05200.pdf_