Banks' funding sources primarily comprise customer deposits and various kinds of wholesale funding. The deposit-to-loan ratio (2) in Norwegian banking groups (banks and mortgage companies combined) has fallen from a good 100% in 1993 to a 60% in 2010. The reason for the sharp decline is that lending growth has outstripped deposit growth. Banks have therefore funded a growing portion of lending through market funding. Of Norwegian banks' market debt at end-March 2011, long-term wholesale funding (3) accounted for approximately 80%. For long-term wholesale funding, banks rely on the bond markets.
Long-term funding stabilises bank funding and reduces banks' risk of having insufficient funds for meeting their obligations when they fall due. This liquidity risk is normally due to maturity mismatches between banks' assets and liabilities. Norwegian banks were adversely affected during the financial crisis because they relied on short-term market funding to finance long-term lending and because their financial assets did not prove to be liquid during the crisis. (4) Short-term funding increases banks' refinancing needs, making them more vulnerable to access to and the price of funding.
In the wake of the financial crisis, the Basel Committee has proposed liquidity coverage and stable funding requirements (see Box 1). The net stable funding ratio will likely restrict the use of short-term wholesale funding. Norwegian banks' volume of outstanding certificates (5) denominated in NOK has fallen sharply since 2005, with the recent decline in volume possibly reflecting Norwegian banks' early adjustment to the proposed new stable funding rules. The proposed new rules for banks' liquidity coverage, new rules for collateral for loans with Norges Bank and new solvency rules for insurance companies (Solvency II) will also affect the ownership composition for bank bonds and covered bonds issued in NOK.
The present article describes Norwegian banks' long-term wholesale funding in the light of developments in credit markets and various regulatory changes. Section 2 discusses the Norwegian bond market and bonds as a funding source. Banks' and mortgage companies' funding structure is described in Section 3, where funding in different currencies and at different maturities is examined in detail. Section 4 provides an assessment of developments in the ownership structure of bank bonds and covered bonds and the extent to which various changes in regulations have impacted ownership composition. Section 5 assesses the liquidity in banks' funding markets by measuring the turnover velocity of outstanding bank bonds and covered bonds. The relationship between liquidity and risk premiums for bank bonds and covered bonds is an indication of the interaction of bond turnover and the cost of bond funding. This relationship is illustrated in further detail in Section 6. Section 7 provides a brief summary.
The Norwegian bond market
The Norwegian bond market is a market for raising funds denominated in NOK. Bonds issued in foreign currency by Norwegian issuers abroad and bonds denominated in NOK issued abroad by Norwegian or foreign issuers are not considered part of the Norwegian bond market.
There was a total of NOK 837bn outstanding in the Norwegian bond market (6) at end-2010. Government bonds accounted for 28% of outstanding debt (see Chart 1). Owing to the Norwegian government's favourable financial position, government participation in the bond market is relatively modest. Norwegian banks had outstanding bonds totalling NOK 256bn in the Norwegian market at end-2010, which represents 31[degrees]% of outstanding debt in the Norwegian bond market. For banks, bonds are a supplement to deposits from customers. Large banks also issue bonds in foreign currency, swapping the foreign currency for NOK through a combination of currency and interest rate swap contracts.
Establishment of the market for covered bonds (OMF market)
The establishment of the covered bond market in June 2007 has provided banks with a new and important source of funding. Covered bonds may be issued by mortgage companies, which primarily rely on such bonds for funding. All mortgage companies in Norway that issue covered bonds are owned by banks. Banks may either transfer residential mortgages or commercial property loans to their mortgage companies, which issue covered bonds collateralised by these loans, or they can provide loans directly from the mortgage company. In this way, banks fund their residential mortgage and commercial property lending though their mortgage companies. As covered bonds are generally highly secure, they can be issued on better terms than unsecured bonds or other paper. (7)
Mortgage companies account for 44% of total Norwegian bank and mortgage company lending secured on dwellings, a share that has grown quickly. (8) Issues of covered bonds accounted for 60% of the total volume of bank and mortgage company bond funding in NOK and foreign currency in 2010 (see Chart 2). This share was 33% in 2007 and 47% in 2008. (9)
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What are the characteristics of Norwegian banks' capital issues in credit markets?
Issues in foreign currency
In recent years, Norwegian banks have diversified their wholesale funding. Norwegian investors lack sufficient investment capital to meet the largest banks' funding needs, and banks are able to issue larger volumes in foreign markets. Bonds denominated in foreign currency give Norwegian banks a broader range of funding options, and thus an alternative to funding in NOK. It can also be cheaper for banks to obtain funding in foreign currency than in NOK, even after the foreign currency funding has been swapped for NOK through interest rate and currency swaps. Half of Norwegian bank and mortgage company bond issues in 2010 were in foreign currency. By comparison, only 10% of the volume of bonds had been issued in foreign currency in 2005. It is the largest banks and mortgage companies that issue foreign currency bonds.
Box 1: Basel III--new rules for liquid assets and stable funding In the wake of the financial crisis, the Basel Committee has proposed introducing two quantitative liquidity tests to supplement existing qualitative requirements. The first is a liquidity coverage ratio, and the other is a net stable funding ratio. The liquidity coverage ratio and net stable funding ratio are to be introduced in 2015 (1) and 2018, respectively. Liquidity coverage ratio (LCR) Under the liquidity coverage ratio, each bank must have a sufficient stock of liquid assets to survive a 30-day period of considerable market stress featuring a substantial outflow of customer deposits, without having access to new market funding or a supply of new liquidity from the central bank. The characteristics an asset must have to qualify for inclusion in the stock have not yet been finalised. However, an asset must be of high quality, highly liquid and unencumbered. Assets which otherwise qualify that have been pledged to the central bank or a public sector entity (PSE) but are not used as collateral may be included in the LCR. Under the Basel Committee's proposal, "Level 2" assets, which are somewhat less liquid than the most highly liquid assets, may comprise a maximum of 40% of the stock. It is primarily covered bonds that may qualify as Level 2 assets in NOK. The Basel Committee has proposed three options for financial institutions in jurisdictions with an insufficient supply of liquid assets in their domestic currency. (2) Since the government securities market in Norway is relatively small, financial institutions domiciled in Norway are likely to be eligible for this alternative treatment, if the Norwegian authorities allow it. (3) Net stable funding ratio (NSFR) To promote longer-term funding of banks, the Basel Committee has proposed a net stable funding ratio (NSFR). The purpose of this standard is to enhance the stability of banks' funding and to avoid maturity mismatches between assets and liabilities. The standard will ensure that long-term assets are funded by a minimum percentage of stable and long-term funding sources. Under the NSFR standard, available stable funding must exceed required stable funding. "Stable funding" is defined as the portion of those types and amounts of equity and liability financing expected to be reliable sources of funds over one-year time horizon during a period of moderate market stress. The share that must be financed by stable funding depends on how liquid the asset is. Banks with long-term loans and a large share of other illiquid assets with long maturities will have to have a substantial portion of long-term funding. (1) Finanstilsynet (the Financial Supervisory Authority of Norway) has directed Norwegian banks to report in accordance with a provisional liquidity coverage ratio as from 31 July 2011. (2) The three options are: 1) Contractual committed liquidity facilities from the relevant central bank, 2) Foreign currency liquid assets and 3) Additional use of Level 2 assets with a higher haircut. These options are described in detail in Financial Stability 1/11 (Box 2), Norges Bank. (3) In Norway, outstanding government securities amounted to around 24% of GDP in 2010. Excluding the amount of outstanding Treasury bills in the swap arrangement, the Norwegian government securities market amounts to around 14% of GDP. See Syed, H. (2010) for a more detailed description of the Norwegian market for government securities in view of new liquidity requirements. [GRAPHIC 3 OMITTED]
For several years, European bond markets have been an important source of funding for Norwegian banks and mortgage companies. More than half of Norwegian bank and mortgage company foreign currency bond issues in 2010 were denominated in euros (see Charts 3 and 4). After 2008, Norwegian banks obtained larger portions of their foreign funding in USD, and beginning in 2010, mortgage companies...
Markets for Norwegian banks' long-term funding--implications of changes in market conditions and the regulatory framework.
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