SECOND HALF OF 1999
NORGES BANK'S REPORTS ON FINANCIAL STABILITY
In addition to its responsibilities in the area of monetary policy, Norges Bank is also responsible for fostering stability in the financial sector, and therefore analyses and reports on the situation in the sector. The work includes both analyses of developments in financial institutions, primarily in the banking sector, and the relationship between macroeconomic developments and financial sector developments. Analyses of the financial position of households and enterprises are important elements.
Since 1995 Norges Bank has produced reports on the situation in the financial sector and the outlook for the sector. The reports are for internal use, but are also made available to the Ministry of Finance and the Banking, Insurance and Securities Commission. Since 1997, excerpts from these analyses have been published in Economic Bulletin nos 2 and 4 under the title `Financial Sector Trends' (from June 1998: `Financial Sector Outlook').
Mood has shifted in international financial markets
The uncertainty in international financial markets has been somewhat reduced over the past year. The situation in the crisis-hit Asian countries has improved, and current account deficits have been reversed to surpluses. Future developments in Latin America are more uncertain. The greatest threat to financial stability internationally is still the risk of a considerable fall in the US stock market. The risk of turbulence in international foreign exchange markets, which can be triggered by growing imbalances in world trade, represents another element of uncertainty.
Indications of an increase in domestic credit growth
Domestic credit growth has slowed consistently in the past year, whereas foreign credit growth has been high. Growth in total credit to the private and municipal sectors has remained at just over 10%. In the last months, however, there have once again been signs of increased growth in credit from domestic sources. Underlying growth in domestic credit has expanded since the end of last year, and in September year-on-year growth returned to the level recorded at the start of 1999. Banks have recorded the highest lending growth in recent months.
A decline in domestic interest rates may have contributed to higher credit demand in the last few months. The continuing rise in house prices indicates that credit demand in the household sector remains strong. A slowdown in business investment suggests lower credit demand. Despite increasing growth in domestic credit in September, a falling trend is expected in the period ahead.
Positive results for banks this year ...
Both commercial and savings banks have achieved far better results this year than in the corresponding period in 1998. The improvement is to some extent due to one-off effects resulting from changes in accounting rules, but also to increased income as a result of developments in the securities markets. Higher net interest income and a slight reduction in operating expenses have also contributed to the improvement in profits. The improvement in net interest income is primarily due to the fact that the interest margin has been higher this year than in the same period in 1998, largely as a result of the rise in interest rates in autumn 1998.
... and some favourable developments in financing structure
Net interest income is also to some extent affected by trends in banks' financing structure which have been more favourable in the past 18 months than in the preceding three years. Foreign financing at the shortest end of the market has been reduced, and the steady decline in the deposit to loan ratio has stopped, at least temporarily. Both these elements help to reduce liquidity risk.
Deterioration in debt-servicing capacity among banks' customers, particularly enterprises
Despite a slight decrease this year, interest rates are still higher than in 1997 and the first half of 1998. Interest expenses for households and enterprises have therefore increased.
Households have generally maintained a sound financial position. Indicators for interest expenses and debt burden imply that the majority of households now have a better debt-servicing capacity than in the early 1990s, despite the increase in interest charges in the past year. Credit risk linked to households will only increase if unemployment should rise dramatically and/or house prices should fall sharply.
The situation is different in the enterprise sector. Strong growth in debt has increased financial exposure in recent years. In addition, profitability has been squeezed as a result of higher costs and intensified competition in several industries.
Accounting figures for 1998 show a clear rise in the number of enterprises with poor earnings and weak or negative equity, ie high-risk enterprises. Financial institutions' exposure to this type of enterprise increased considerably in 1998. This is primarily ascribable to a deterioration in existing loan customers' financial position. It appears that financial institutions are showing more caution in granting credit, as a smaller share of new loans were extended to enterprises classified as high risk in 1998 than in 1997. Overall, however, credit risk in financial institutions has increased.
But no clear rise in non-performing loans or loan losses
The increase in credit risk linked to corporate debt has so far not given rise to any sharp increase in the volume of nonperforming loans, nor has there been any significant increase in recorded losses.
Banks continue to face considerable challenges in the period ahead
The trend in banks' earnings and financial strength in the current year has helped to limit vulnerability in the financial sector. Future challenges include the competitive situation and possible trends for banks' interest margins, as well as higher credit risk, and associated prospects of an increase in loan losses. If banks are to achieve earnings which can contribute to maintaining financial strength, it is possible that individual institutions will have to implement various measures, such as cost reductions and a greater emphasis on the correct pricing of risk.
It is likely that activity in parts of the financial market will be lower and in some areas differ from the norm at the end of a year, in connection with the transition to the year 2000. Norges Bank does not expect any serious disturbances in the financial system in connection with the year 2000 (see separate box).
[Charts 1.1-1.6 OMITTED]
2 INTERNATIONAL AND NORWEGIAN SECURITIES MARKETS
2.1 Developments in international financial markets
In the course of the past year, the mood in international financial markets has shifted from fear of a global recession to concern about rising inflation. The situation in the crisis-hit Asian countries has improved, and current account deficits have been reversed into large surpluses. The situation in Latin America is more uncertain. Sluggish growth and higher interest rates internationally make it difficult to redress the financial imbalances in a number of the countries. The greatest threats to financial stability internationally are still the possibilities of a negative reaction in the US equity market, and turbulence in international currency markets triggered by growing imbalances in world trade.
Rising interest rates contribute to more moderate equity price performance
There has been a global rise in long-term interest rates. Interest rates in the large countries have risen most in the US and some euro area countries, by almost 2, and about 1.5 percentage points, respectively, since the lows of about one year ago (see Chart 2.1). The rise in interest rates has been appreciably less in Japan. Virtually the same interest rate increase in Europe and the US may seem rather surprising in view of the fact that the two areas are at different stages of the business cycle. In both areas, however, there has been strong growth in credit to the private sector - in excess of 10%. In many countries, the increase in long-term interest rates has been followed by a tightening of monetary policy. This appears to have dampened fears of inflation, and contributed to lower long-term interest rates recently.
[Chart 2.1 OMITTED]
The differential between government bond yields and swap rates with a corresponding maturity remains distinctly higher than the levels in 1997 and the first half of 1998 (see Chart 2.2). This illustrates the fact that credit and liquidity risk associated with banks, and possibly also other non-government borrowers, is still regarded as higher than normal.
[Chart 2.2 OMITTED]
For a long time, equity markets were unaffected by the rise in interest rates, but during the autumn equity prices fell in many countries (see Chart 2.3). Recently they have risen again, and some have passed the record quotations of the summer of 1999. In the US, the Standard & Poor 500 index has tripled since 1994. this is the reason for the concern as to whether the US equity market is overvalued (see discussion in separate box).
[Chart 2.3 OMITTED]
Improvement of the situation in Asia ...
The crisis-hit countries in Asia have performed a sweeping turnaround in the last 2 1/2 years. The devaluation of currencies and contraction in domestic demand have led to the combined current account balance of these countries going from a deficit of over USD 50 billion in 1996 to a surplus of almost USD 70 billion in 1998 (see Table 2.1). The counterpart to this is an almost equally large change in the previously large inflows of private sector capital. In combination with the large inflows of public sector capital, the large operating profits have provided scope for a substantial accumulation of foreign exchange reserves. The IMF expects somewhat lower current account surpluses this year and in 2000 as a result of the recent appreciation of currencies and the rise in domestic demand.
Table 2.1 Movements of...