How large are the financial margins of Norwegian households? An analysis of micro data for the period 1987-2004.

Author:Vatne, Bjorn Helge

In this article, financial margins in Norwegian households are calculated using micro data for the period 1987-2004. Financial margins are defined as household liquid assets after borrowing costs and ordinary living expenses. This is an indicator of the resilience of household finances to changes in economic conditions such as an increase in interest rates or a reduction in income. Hence, margins can provide information about the risk of losses on bank loans to the household sector. Overall household margins increased substantially from the end of the 1980s to 2004 due to strong income growth coupled with a reduction in the share of income used to cover ordinary living expenses and borrowing costs. Most households have solid margins, although some households have small or negative margins. The share of households with negative margins has decreased over the period analysed.

1 Introduction

In assessing the risk associated with loans from financial institutions, it is important to monitor household debt for two reasons. First, a substantial reduction in households' debt-servicing capacity may increase losses on financial institutions' loans to the household sector. Second, households in financial distress may substantially reduce spending on goods and services. This, in turn, may affect corporate earnings and contribute to increasing losses on bank loans to the business sector.

Financial margins, which are defined as liquid assets after ordinary living expenses and borrowing costs, may shed light on these questions. In this article, micro data are used to calculate the margin of individual households. In Section 2, we present the data and consider the relationship between banks' non-performing loans and household margins. In Section 3, we calculate the total value of households' positive margins to investigate developments in household liquid assets, i.e. assets for consumption in excess of ordinary living expenses and for saving in excess of loan repayments. In Section 4, we look more closely at the portion of debt held by households with negative margins and the characteristics of these households. In Section 5, we analyse how margins are affected by changes in the interest rate, and in Section 6, we summarise our findings.

2 Background

Why study the financial margin in individual households?

Norges Bank monitors household debt as part of its surveillance of financial market risk. Total household debt as a percentage of total disposable income is often used to measure this risk (see, for example, Financial Stability 1/06). This indicator has some limitations, however, because it is an aggregated variable. First, this income also includes income from debt-free households. Second, the indicator does not take into account income levels. Households with high income can service relatively more debt than low-income households. Third, the indicator does not take into account fundamental differences between households, such as age, number of household members and number employed.

Access to data at the household level allows us to calculate household financial margins which reflect the financial situation of households. The calculations are similar to the calculations made by banks when they assess household loan applications.

Banks base their assessments on household income. Ordinary living expenses calculated on the basis of household composition are then deducted. On the basis of the resulting disposable income, banks calculate the maximum loan level based on assumptions concerning interest rates and repayment profiles. However, future debt-servicing capacity is uncertain. Interest and principal payments must be paid over the entire life of the loan, whereas various factors such as changes in income and interest rates or changes in household composition affect the financial situation of households.

The data allow us to identify households with a negative margin. We assume that the financial situation of these households is strained. This household debt is particularly vulnerable to default and will hereafter be referred to as exposed debt. Exposed debt as a share of total debt may be an indicator of the direct risk associated with bank loans to the household sector. Total margins are defined as the sum of margins in households with a positive margin. We consider total margins to be an indicator of total household demand for goods and services from non-financial enterprises. This demand will affect corporate earnings and debt-servicing capacity.

The data comprise too few observations to determine whether there is a stable correlation between margins and loan defaults. Chart 1 indicates that there is a correlation. The bottom curve shows the default rate on all bank loans, which is defined as the value of banks' non-performing loans to households and non-financial enterprises as a share of total lending. There is a positive correlation between the share of exposed debt and default rates. The turning points of exposed debt seem to precede the turning points of default rates. A possible explanation is that households have financial assets on which they can draw for a period before defaulting on loans. There is a negative correlation between the default rate...

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