Collateral for loans from Norges Bank--new rules.

• Author: Bakke, Bjorn

Norges Bank extends loans to banks against collateral in the form of securities. These loans are provided in connection with payment settlement and the implementation of monetary policy. Since the bond market in Norway is relatively small, Norges Bank has up to now accepted a broad range of securities as collateral. Norges Bank has thereby accepted a higher level of risk in its lending to banks than a number of other central banks. In recent years, banks' available resources in Norges Bank--sight deposits and unutilised borrowing facilities--have increased more than borrowing requirements. This has made it possible for Norges Bank to adapt the rules for collateralisation so that they are more in line with rules in other countries. The article describes Norges Bank's previous rules for collateral for loans, the background for the changes that have been made, the new rules and the consequences the changes might have for banks.

1. Introduction

   Norges Bank has required its loans to banks to be fully collateralised since 1999. Banks' borrowing facilities are determined by their collateralisation, which can vary from day to day. (2) In 2005, banks' borrowing facilities largely varied between NOK 100 and 160 billion. Borrowing facilities in Norges Bank are in general important for payment settlement and the implementation of monetary policy, but small and medium-sized banks primarily use the facilities to meet the liquidity reserve requirement. (3) Collateralisation is to reduce the risk that Norges Bank will incur losses if a bank is placed under public administration. Norges Bank's requirements should therefore ensure that securities used as collateral are readily negotiable and have high creditworthiness even in periods of financial turbulence.

   Government bonds are not issued to any great extent in Norway, and the supply of bonds from other public authorities has also been limited. Other types of bonds were therefore accepted as collateral in Norges Bank when the requirement for full collateralisation was introduced in 1999. These included corporate bonds and bank bonds (bonds issued by Norwegian banks and mortgage companies owned by Norwegian banks).

   These liberal rules meant that Norges Bank accepted a higher level of risk than most other comparable central banks. A number of factors have now made it possible to change the rules in order to reduce Norges Bank's risk. First, banks' borrowing facilities have increased more than borrowing requirements. Second, the new Act relating to financial collateral (2004) provided for immediate realisation of collateral, allowing for banks' borrowing facilities to be calculated on the basis of market value rather than nominal value. Third, provisions have been made for the issue of asset-backed bonds in Norway. These bonds may account for a large share of banks' collateral in a few years' time.

   On the basis of the above, Norges Bank has drawn up new rules. The most important changes they introduce are that i) Norges Bank will calculate banks' borrowing facilities on the basis of market value, ii) haircut rates for securities have been reduced, iii) rating requirements for Norwegian corporate bonds have been introduced, iv) a minimum-volume requirement has been introduced for bonds issued by Norwegian banks and mortgage companies owned by Norwegian banks, and v) further provision has been made for collateralisation of asset-backed bonds.

   The rules were adopted by Norges Bank in August 2005 once they had been circulated for comment to the Norwegian Savings Banks' Association, the Norwegian Financial Services Association and Kredittilsynet (Financial Supervisory Authority of Norway). The rules entered into force on 24 October 2005, although parts will not apply until I November 2007. The changes on 24 October resulted in an increase in banks' borrowing facilities.

2. Norges Bank's previous collateral requirements

   Banks can raise two types of ordinary loans in Norges Bank. (See box on borrowing facilities.) The first type is the D-loan (overnight loan), which is used in connection with payment settlements. The other is the F-loan (fixed-rate loan with varying maturity that cannot be terminated), which is used in connection with the implementation of monetary policy.

   2.1 Norges Bank's lending requirements from 1965 to 1999

   Today, Norges Bank requires banks' loans to be fully collateralised. A similar requirement has applied in earlier periods, but in 1965 collateralisation requirements were relaxed. (4) In 1986, all collateralisation requirements were removed as a result of the currency crisis. At that time, Norges Bank supplied considerable liquidity in order to prevent a sharp increase in money market rates. Norges Bank was thereby left with large unsecured claims on banks that encountered solvency problems during the following years' banking crisis.

   After consultation with the political authorities, Norges Bank provided income support in 1988 and 1989 to a savings bank in the form of subsidised interest rates and by writing down loans. In Report No. 24 (l989-1990) to the Storting concerning the banking crisis, the Ministry of Finance stated that "Writing down central bank loans to banks may (...) represent an active use of government funds that should be deliberated by the Storting in advance". The Ministry also assumed that ordinary legislative procedures would be followed in any future crisis situations in Norwegian banks and referred to the schemes established through the guarantee funds. The Standing Committee on Finance endorsed this view in its follow-up in Recommendation no. 90 (1989-90) to the Storting. This served to further clarify the division of responsibilities between the central bank, the guarantee funds and government authorities in the financial safety net. It was specified in particular that Norges Bank itself shall not increase its risk and impose losses on the state.

   It was difficult to reintroduce collateralisation requirements in subsequent years. Banks had large loans but limited holdings of securities that could be used as collateral. The size of banks' loans was reduced in the course of 1993, however, and Norges Bank introduced a requirement for partial collateralisation of D-loans towards the end of the year. Norges Bank introduced a requirement for full collateralisation of D-loans from 1995, and the same requirement was introduced for F-loans in 1999.

   In 1999 there was some uncertainty as to whether banks had adequate holdings of bonds that could be used as collateral. As a result, new types of bonds were also approved as collateral in Norges Bank when the requirement for full collateralisation of F-loans was introduced. These included bonds issued by private undertakings within the OECD area, bonds issued by Norwegian undertakings and bonds issued by Norwegian banks. Some of these bonds are less liquid and have lower creditworthiness than bonds approved by Norges Bank before 1999.

   2.2 Main features of the 1999 rules

   Banks' borrowing facilities were determined by the value of bonds they had furnished as collateral. For a bond to be used as collateral, the issuer had to be approved by Norges Bank. Different issuers were approved for Norwegian bonds and foreign bonds (within the OECD). Of Norwegian issuers, the government, state-owned enterprises, municipal authorities, county authorities, banks, mortgage companies and private undertakings were approved. Norges Bank also approved ownership interests in Norwegian securities funds as collateral. Of foreign issuers, Norges Bank approved governments and private undertakings with a satisfactory credit rating. (5)

   Bonds issued by Norwegian private undertakings had to be registered in an approved securities depository, be listed on the stock exchange and have a remaining fixed-rate period of no more than 10 years. If the bonds were issued by private Norwegian undertakings without a credit rating, there was an additional requirement that the volume outstanding should be at least NOK 300 million. Bonds from other Norwegian issuers (public authorities, banks and mortgage companies owned by banks) were not subject to requirements related to volume, fixed-rate period or listing on the stock exchange. Bonds with foreign issuers had to have a credit rating, be registered in an approved securities depository, be listed on the stock exchange and have a remaining fixed-rate period of no more than 10 years.

   Bonds and notes issued by Norwegian banks and mortgage companies owned by Norwegian banks were subject to a quota arrangement. Under this arrangement, only up to 50 per cent of a bank's total collateralisation could be in the form of these bonds. The quota also included bonds and notes issued by companies where Norwegian banks directly or indirectly owned more than 1/3, and Norwegian bond and money market funds registered in the Norwegian Securities Depository (VPS).

   A bond was given a loan value equivalent to the nominal value of the bond less a haircut. The size of the haircut depended on the issuer and on whether the bond was denominated in Norwegian kroner or foreign currency...