Liquidity risk for a bank is the risk that it will not meet its obligations when due, without incurring substantial additional costs. As banks have become more reliant on borrowing from wholesale markets, the liquidity of these markets has become very important for banks. It was because these markets had dried up that Norway and most advanced countries experienced a liquidity crisis in autumn 2008.
The global financial turmoil began in summer 2007 when large financial institutions and other market participants realised that it was difficult to value securities collateralised by loan portfolios. Most major banks had, and still have, considerable exposures to such securities. For that reason, investors began to doubt the solvency of the banking sector as a whole, making it harder for banks to obtain wholesale funding. The situation gradually deteriorated, and in March 2008 the US investment bank Bear Stearns was unable to finance continued operations and was taken over by JP Morgan Chase. Uncertainty regarding banking sector solvency continued through summer 2008, becoming an acute problem when the investment bank Lehman Brothers failed on 15 September 2008. This was followed by a period when it was very difficult for banks in nearly every country to obtain wholesale funding. A shortage of liquidity in one segment of the money market had developed into an acute bank funding crisis. Authorities in a number of countries implemented extensive measures in the form of loans to banks and by attempting to improve liquidity in the money market.
There are currently few studies of how banks adapted to liquidity problems in autumn 2008. The economists de Haan and van den End (2011) conducted an analysis of the way Dutch banks reacted. Their econometric model was estimated on the basis of detailed monthly balance sheets for the biggest banks. They find that banks generally react to liquidity problems by reducing corporate lending, hoarding liquid assets and selling off some illiquid assets.
Norwegian banks that obtained wholesale funding internationally noticed problems as early as summer 2007. Following the bankruptcy of Lehman Brothers, the shortage of wholesale funding became so acute that it was impossible to fix the Norwegian interbank rate (NIBOR). NIBOR is calculated as a USD rate plus the price of a currency swap agreement from USD to NOK, which is why it was directly affected by the situation in the US money market. (2) Norges Bank responded by supplying more liquidity to banks than usual. In addition to increasing krone liquidity on 15 September through two extra F-loan auctions with maturities of two days, on the following day, Norges Bank also provided loans in USD to Norwegian banks. This was the beginning of a long period of extraordinary liquidity provision to Norwegian banks. (3)
Norges Bank conducts monthly liquidity surveys, which provide amounts for funding needs in the five biggest Norwegian-owned banks and Nordea (4). In autumn 2008, data were collected twice a month, in both November and December. Short-term net funding needs within a horizon of up to one year increased from August to October. However, beginning in December, very short-term needs, within a horizon of a month, became appreciably lower. There was also a slight decline in needs within slightly longer horizons. The reversal is likely due to the entry into force of a special swap arrangement (5) as from 24 November and banks' ability to use the Treasury bills they obtained from this arrangement to obtain more long-term funding. The acute crisis appears to be over in December.
In the following we will describe in more detail how Norwegian banks were affected by the financial turmoil in autumn 2008. We are concentrating on the phase during which liquidity problems were most severe: 15 September to 30 November 2008. We examine the banking sector as a whole and three main categories of banks and investigate whether these categories were affected or behaved differently.
The analysis is based on various sources to which Norges Bank has access. As much of the source material used is confidential, the article does not contain figures that can be linked to a particular bank.
Statistics Norway's Banking Statistics provide balance sheet and other financial statement information for each bank. Balance sheet information at month-end allow us to study the composition of balance sheets and how this composition changed during the autumn of 2008. From the financial statements we mostly use figures for deposit rates, which are available at the end of each quarter.
Stamdata is a database operated by Norsk Tillitsmann ("Norwegian Trustee"), which contains information on banks' issuances of notes and bonds. The information pertains to the actual issue and does not provide prices in the secondary market. Secondary market trading in these securities is so modest that the information would be of little relevance.
Norges Bank operates the settlement system for banks and thus has information on interbank payments. This information can be used to estimate the interest rates paid by banks for interbank loans (see Akram and Christophersen (2010)).
Norges Bank provides loans to banks against collateral. We thus have data on pledged collateral from each bank, and we know how much each bank has borrowed and at what rate.
Balance sheet developments, autumn 2008
3.1 Banking sector as a whole
Table 1 shows the banking sector's balance sheet at end-August 2008, that is, before the most acute phase of liquidity problems. The table includes both Norwegian-owned banks and subsidiaries and branches of foreign banks in Norway, but not the branches of Norwegian banks abroad. (6) We have specified the items that are most relevant for assessing banks' liquidity situation.
The problem in autumn 2008 was primarily access to wholesale funding, i.e. notes and bonds and loans and deposits from other financial institutions. The table shows that customer deposits in August 2008 accounted for only 43%, that is, less than half of the total need for funding the balance sheet total. Deposits and loans from other credit institutions covered 23% of funding. This was largely foreign parent banks' funding of their subsidiaries and branches. Moreover, 16% of funding came from bonds that banks had issued in NOK, and a further 3% from notes. All together, more than 30% of funding was from foreign financial institutions or in foreign currency.
Table 2 shows how the shares of selected items changed in the three months from August to November 2008. The most conspicuous change is the nearly 13% increase in the balance sheet total in these three months. Some of this is due to the depreciation of the krone in autumn 2008 and subsequent revaluation of foreign currency assets and liabilities. But the increase was sharp even if we disregard changes in exchange rates (see section 3.2.1). At the same time, the absolute scale of lending to and deposits from customers changed little. The share of these core activities represented in the balance sheet total was thus sharply reduced. More than two thirds of the increase on the asset side took the form of deposits in Norges Bank and in other banks. These deposits accounted for 6 percentage points more of the balance sheet total in November than in August. Banks increased their balance sheets to ensure they had larger stocks of liquid assets.
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More than half of the increase in the balance sheet total was funded by loans from Norges Bank and foreign parent banks. A further sixth came from issuance of notes and bonds in foreign currency.
3.2 Categories of banks
We shall focus on three categories of banks, namely the six biggest Norwegian banks (7), other Norwegian banks and subsidiaries and branches of foreign banks. These are not completely homogeneous categories, yet at the same time there are clear differences between them. This provides a basis for examining differences in banks' reaction to the liquidity crisis. The three categories held 47%, 21[degrees]% and 32%, respectively, of the banking sector's total assets at end-August 2008.
3.2.1 Asset side of the balance sheet
We begin by looking at the composition of banks' asset side in August 2008 (Chart 1). We see that the share of lending to customers differs widely between groups, with a very high share in the category of smaller Norwegian banks and as much as 20 percentage points lower in the category large Norwegian banks. Subsidiaries and branches of foreign banks are approximately in between. This reflects the fact that the larger banks have substantial other business in addition to lending activities.
At the same time, the biggest banks have a considerably larger share of their balance sheets as deposits in foreign banks and bonds in foreign currency than smaller banks. The smaller banks have more of their liquid reserves in Norges Bank and in NOK bonds.
Table 3 shows how the composition of the asset side changed in the three months from August to November 2008. Balance sheets appear to have increased in foreign banks in particular, while the increase in the balance sheets of smaller Norwegian banks was relatively modest. The six biggest Norwegian banks' balance sheets also increased substantially, but considerably less than for foreign banks.
Some of the increase in balance sheets is due to changes in exchange rates. The Norwegian krone fell by approximately 12% against the euro and around 30% against the US dollar during these three...
Banks' liquidity situation during the financial turmoil in autumn 2008.
|Author:||Berg, Sigbjorn Atle|
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