Risk Outlook – June 2022

Vulnerabilities in the Norwegian financial system

High debt in Norwegian households and elevated property prices represent the key vulnerabilities in the Norwegian financial system. The debt burden of Norwegian households is high, both in historical terms and compared with other countries. Almost all of the debt carries floating interest rates or has a short fixed-rate period.

“Many households have very high debt relative to income and the value of their property. These are vulnerable to declining incomes, rising lending rates and falling house prices,” says Finanstilsynet’s Director General, Morten Baltzersen.

House prices in Norway have risen considerably over a protracted period, and the price level is significantly higher than prior to the pandemic. The protracted low interest rate level has been a key factor behind the rise in house prices. A sharp rise in interest rates may trigger a substantial fall in house prices.

“If a large number of households have to reduce their purchases of goods and services at the same time, it could have major negative ripple effects in the economy and the financial system,” says Baltzersen.

Commercial property prices in Norway have risen sharply over many years and are now very high.

“A strong rise in interest rates or significantly higher risk premiums may lead to a substantial fall in commercial property prices and heightened credit risk for the banks,” says Baltzersen.

The risk of cybercrime is increasing. During the Covid-19 pandemic and in connection with the war in Ukraine, the key institutions in the financial infrastructure have demonstrated a high level of emergency preparedness. However, the threat picture is constantly changing. Close interconnectedness in the financial system raises the risk that individual incidents will escalate, affect more market players and lead to financial instability.

The banks’ profitability and solvency

Norwegian banks enjoy strong profitability, and the banks' loan losses have been low in 2021 and so far in 2022. The banks have generally preserved their solvency levels and meet current capital requirements by a margin.

Finanstilsynet's stress test of Norwegian banks’ capital adequacy shows that Norwegian banks may be severely affected if the global economy enters a long period of high inflation, interest rate hikes and lower economic growth. In the stress scenario, household finances deteriorate sharply, corporate earnings are severely affected, and banks' losses on loans to non-financial firms and households rise considerably. There is a steep decline in banks’ capital adequacy ratios. Almost half of the banks are in breach of the regulatory requirements for common equity Tier 1 capital during the stress period.

“Finanstilsynet expects banks’ capital planning to factor in the considerable uncertainty that prevails about future economic developments. It is vital that the banks are well capitalised to be able to absorb loan losses and provide loans to creditworthy customers during an economic downturn,” says Baltzersen.