FINANCIAL STABILITY
HENRIK BORCHGREVINK
UIO
APRIL 22 2016
Disclaimer
The views are those of the author and do not necessarily
reflect those of Norges Bank
2
Outline
 What is financial stability?
 Banks and financial stability
 Systemic risk (Financial stability risk)
 Financial stability analysis (FSR 2015)
 Financial stability and macroprudential policy
3
What is financial stability?
Financial stability implies a financial system that is resilient to shocks and
thus capable of channelling funds, executing payments and distributing
risk efficiently
Difficult to “measure” financial stability
4
Cyclical risks: The financial cycle (US)
5
Business cycle and credit cycle in Norway
6
20
4
10
2
0
0
-2
-10
-4
Business cycle
-6
1992
Credit cycle
-20
1995
1998
Sources: SSB and Norges Bank
2001
2004
2007
2010
2013
6
The role of debt
 Jorda, Schularick og Taylor: The more debt accumulated prior to the
recession, the deeper and more prolongued is the recession
– Study of more then 200 recessions in 14 countries (1870-2008)
– Holds for normal resession and recessons with crisis (but strongest for the latter)
 “Over-investment and over-speculation are often important; but they would
have far less serious results were they not conducted with borrowed money”
(Irving Fisher, «The debt-deflation theory of great depressions»,
Econometrica, 1933)
Financial crises in Norway
Financial crisis
2008-09
Bank crisis
in Oslo
1899-1905
Sources: Statistics Norway and Norges Bank
International
bank crisis
1920-28
Bank crisis
Norway
1988-93
8
BANKS AND FINANCIAL STABILITY
9
Banks execute payments …
Bank 1
Bank 2
Customer
Bank 1
Customer
Bank 2
10
… and act as credit intermediaries
Loan
Financing
11
Bank balance: Assets match financing
Deposits
Loans
Market
financing
Equity
12
SYSTEMIC RISK
«FINANCIAL STABILITY RISK»
13
Systemic risk
Systemic risks to financial stability are risks of disruption to the financial system with
the potential to have serious consequences for the real economy
(European Systemic Risk Board)
14
Categories of systemic risk
Excessive exposure
concentrations in the
financial system
Excessive credit
growth and leverage
Systemic risk
Excessive maturity
mismatch and market
illiquidity
Source: ESRB
Misaligned incentives,
particularly in
systemically important
institutions
15
Two conceptual dimensions of systemic risk
1. Cyclical systemic risk: The evolution of system-wide risk over time –
the “time dimension”
2. Structural systemic risk: The distribution of risk in the financial system
at a given point in time – the “cross-sectional dimension”
16
Cyclical dimension: Credit cycle
 (De)regulation
 Overoptimism
–
Risk being underestimated in upturns, and overestimated in downturns.
 Financial accelerator: Debt and property prices amplify each other

Bernanke, B. S., M. Gertler, and S. Gilchrist (1999). The financial accelerator in a quantitative business cycle framework. Handbook of
Macroeconomics 1.
 Individual borrowers and banks do not fully take into account the gradual increase in the
economy's vulnerability to shocks as debt rises (pecuniary externality)

Bianchi, J. (2011). Overborrowing and systemic externalities in the business cycle. AER 101.
17
Structural dimension: bank assets/GDP
18
FINANCIAL STABILITY ANALYSES
FINANCIAL STABILITY REPORT 2015
19
Financial stability reports
20
Financial stability reports
21
MPR 1/16 Indicators of financial imbalances
Credit/GDP
House prices/disposable income
200
200 200
200
150
150 150
150
100
100 100
100
50
50
1976
1986
1996
2006
2016
Real commercial property prices
200
200
150
150
100
100
50
1981
50
1991
Kilde: Norges Bank
2001
2011
50
1979
1989
1999
2009
Bank’s wholesale funding ratio
60
60
40
40
20
20
0
1976
1986
1996
2006
50
0
2016
22
Effects with Respect to
Marginal effects on crisis probability
Anundsen et al. (2014) :Bubbles and crises: « The role of house prices and credit” http://static.norgesbank.no/pages/101680/Working_Paper_14_2014.pdf?v=12/10/201593321AM&ft=.pdf
Equity/Assets
House Prices to Inc. Gap
Wholesale Funding Gap
NFE Credit to GDP Gap
Household Credit to GDP Gap
-4
-2
0
2
Marginal Effect on Crisis Probability (pp)
4
23
Credit as a share of GDP with three
different trend calculations
Percent
200
175
150
200
Crises
Credit/GDP
HP filter, extended
HP filter
10-year rolling average
175
150
125
125
100
100
75
1976
75
1984
1992
Sources: Statistics Norway and Norges Bank
2000
2008
24
Financial stability reports
25
Financial stability report 2015
Key vulnerabilities in the Norwegian financial system
Change since
FSR 2014
High household debt
Persistently strong rise in real estate prices
Banks’ short-term foreign currency funding
26
Household vulnerability
From the executive board’s assessment FS 2015
 Household debt burdens are high. Debt growth is lower than in the
years preceding the financial crisis, but household debt is still growing
more rapidly than household income
 Younger households in particular are vulnerable because of high debt,
a high interest burden and limited assets other than housing wealth
 With high levels of debt, households faced with a drop in income, an
increase in interest rates or a fall in house prices may tighten
consumption considerably. This could amplify a downturn and lead to
higher bank losses
27
Household debt
Debt to after-tax income ratio by age. Percent
350
350
1987 – 1989
1990 – 1999
2000 – 2009
2010 – 2013
300
300
250
250
200
200
150
150
100
100
50
50
0
0
0 – 24
25 – 34
35 – 44
Sources: Statistics Norway and Norges Bank
45 – 54
55 – 64
65 – 74
75 –
28
The distribution of debt has changed
Distribution of debt by age. Percent of total debt.
40
40
1987 - 1989
35
1990 - 1999
35
30
2000 - 2009
30
25
2010 - 2013
25
20
20
15
15
10
10
5
5
0
0
0-24
25-34
35-44
45-54
55-66
67-76
7629
Households vulnerable to interest rate increases
Households’ interest burden. Percent
Sources: Statistics Norway and Norges Bank
Financial stability report 2015
Key vulnerabilities in the Norwegian financial system
Change since
FSR 2014
High household debt
Persistently strong rise in real estate prices
Banks’ short-term foreign currency funding
31
Persistent rise in real estate prices
Index. 1998 Q4 = 100
32 Bank
Sources: Eiendom Norge, Eiendomsverdi, Finn.no, Dagens Næringsliv, OPAK, Statistics Norway and Norges
Persistent rise in real estate prices
House prices/disposable income
Real commercial property prices
200
200
150
100
50
1979
200
200
150
150
150
100
100
100
50
1989
1999
2009
50
1981
50
1991
2001
2011
33
Financial stability report 2015
Key vulnerabilities in the Norwegian financial system
Change since
FSR 2014
High household debt
Persistently strong rise in real estate prices
Banks’ short-term foreign currency funding
34
Funding of Norwegian banks
35
Banks’ short-term foreign currency funding
 14 %of banks’ wholesale funding is
short-term FX, primarily USD
 The percentage share varies
considerably over time
 Experience shows that short-term
funding can dry up abruptly and prove
difficult to replace
 Reacts to news about Norwegian
economy
36
Declining maturity
Average maturity of US MMFs’ assets. Days. 3 Jan 2014 – 27 Oct 2015
 Sources: J.P. Morgan and Norges Bank
37
STRESS TEST
Stress test of the Norwegian «macro bank»
Top-down stress test 7 largest Norwegian banks
Stress scenario 2016-2019:
 Growth among trading partners fall markedly
 Oil price at 30 dollars, rising towards 50 in 2019
 Substantial repricing of all risk premiums
 (Key policy rate at ZLB; CCB set to zero)
39
Pronounced downturn in Norway
House prices. 2015=100
Unemployment. Percent
8
8 120
120
7
100
5
7 100
6
80
5
4
4
3
3
2
2
1
0
80
0
0
Sources: NAV, Statistics Norway, Eiendom Norge, Finn.no, Eiendomsverdi and Norges Bank
2017
0
2013
20
2009
20
2005
1
2001
40
1997
40
1993
60
1989
60
1985
6
40
Macro bank’s problem loans
Percent of lending to sector.
20
20
Enterprises
Households
15
15
10
10
5
5
0
1990
0
1993
1996
1999
2002
Sources: Statistics Norway and Norges Bank
2005
2008
2011
2014
2017
41
Equity ratio (CET1) in the adverse scenario
Percent Q2 2014 – Q4 2019
16
14
12
10
8
6
4
CET1
2
CET1 requirement (CCB=0)
0
2014
2015
Source: Norges Bank
2016
2017
2018
2019
42
Banks are exposed to CRE and construction
Percent of banks’ loans to corporates
10%
Construction
44%
46%
CRE
Other
Source: Norges Bank
43
Stress test with different CRE&Construction losses
Percent
16
16
14
14
12
12
10
10
8
8
6
Losses/Loans = 3%
6
Losses/Loans = 5%
4
2
0
2014
4
Losses/Loans = 7%
2
CET1 requirement (CCB=0)
0
2015
Source: Norges Bank
2016
2017
2018
2019
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Summary
 Strong growth in debt and property prices is a sign that financial
imbalances has been build up. Recent developments suggest that the
imbalances have not built up further (MPR 1/16)
 Key vulnerabilities for financial stability (FSR 2015)
– High level of household debt
– Persistently strong rise in real estate prices
– Bank’s short-term foreign currency funding
 The stress test of the Norwegian banking sector shows that the banks
could experience high loan losses in the event of a pronounced
downturn in the Norwegian economy without breaching the minimum
capital adequacy requirement
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FINANCIAL STABILITY AND
MACROPRUDENTIAL POLICY
Monetaryand fiscal
policy
Price stability
Stable production
Banking
supervision
Financial stability
Systemic risk
Financial stability
Bank specific risk
47
New instruments
Monetaryand fiscal
policy
Macro
prudential
policy
Banking
supervision
Price stability
Stable production
Financial stability
Systemic risk
Financial stability
Bank specific risk
48
Micro- and macroprudential
 Both focus on financial institutions, similar tools, but different objectives:
 Microprudential:
–
Objective: to mitigate bank specific risk
–
Is each individual bank prudent with sufficient capital according to regulation?
 Macroprudential:
–
Objective: to mitigate systemic risk
–
Does the banking system have sufficient buffers to meet huge losses, so that they
are still able to provide credit to households and firms in a downturn?
49
Policy trade-offs: macroprudential
policy versus microprudential policy
1. When systemic risk is high/increasing
–
–
A macroprudential regulator would typically want higher capital ratios
Not necessary in conflict with microregulator
2. In a crisis situation a tradeoff occure:
–
–
A macroprudential regulator would typically allow capital levels in banks to be
reduced so as to sustain the flow of credit to the real economy
A microprudential regulator would typically want to maintain capital ratios to
ensure the soundness of individual banks
“the macroprudential approach to financial regulation as an effort to control the social
costs associated with excessive balance-sheet shrinkage on the part of multiple
financial institutions hit with a common shock”
Hanson, S. G., A. K. Kashyap, and J. C. Stein (2011). A macroprudential approach to financial regulation.Journal
of Economic Perspectives 25 (1), 3-28
50
Policy trade-offs: monetary policy and
macro-prudential policy
Source: Dunstan (2014)
51
Potential conflic when the business and
credit cycle diverge..
6
20
4
10
2
0
0
-2
-10
Loose MP
Tight micropru
Macropru?
-20
-4
Business cycle
-6
1992
1995
1998
Kilder: SSB og Norges Bank
2001
2004
Credit cycle
2007
2010
2013
52
Financial stability in Norway- division of
responsibilities
 The Ministry of Finance has overriding responsibility for ensuring that Norway
has a well functioning financial industry.
–
–
Regulations (system and capital levels)
Crisis resolution
 Financial Supervisory Authority of Norway has a particular responsibility for
solvency, management and control in financial institutions.
–
direct supervisory authority over financial sector participants
 Norges Bank is responsible for promoting a robust and efficient financial system
–
–
–
Monitor the financial system, institutions, securities market and payment system to
identify trends that may weaken the stability of the financial system
Give advice on counter cyclical buffer and other measures the bank finds necessary
Lender of last resort
53
Implementation of macroprudential policy
in Norway
 Regulation on requirements for residential mortgage loans (2015)
–
Maximum loan-to-value of 85 percent
–
Debt-servicing capacity requirement
–
Amortization requirement
 Higher capital requirements (2013-2016)
–
Systemic risk buffer
–
Buffer for systemically important banks
–
Countercyclical capital buffer
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Relevant literature

Anundsen et al (2014) :Bubbles and crises: « The role of house prices and credit” http://static.norgesbank.no/pages/101680/Working_Paper_14_2014.pdf?v=12/10/201593321AM&ft=.pdf

Bernanke, B. S., M. Gertler, and S. Gilchrist (1999). The financial accelerator in a quantitative business cycle framework. Handbook of
Macroeconomics 1. http://www.econ.nyu.edu/user/gertlerm/BGGHandbook.pdf

Bianchi, J. (2011). Overborrowing and systemic externalities in the business cycle. AER 101.
https://www.aeaweb.org/articles?id=10.1257/aer.101.7.3400

Borchgrevink et al (2014): «Macroprudential regulation - what, why and how?” http://static.norgesbank.no/pages/101524/Staff_Memo_13_2014_eng.pdf?v=10/20/201435914PM&ft=.pdf

Dunstan, A. (2014): «The interaction between monetary and macro-prudential policy» http://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Bulletins/2014/2014jun77-2dunstan.pdf

ESRB: Flagship report on Macroprudential policy in the Banking sector:
https://www.esrb.europa.eu/pub/pdf/other/140303_flagship_report.pdf

Norges Bank:
–
Financial Stability 2015 (chapter 1 – 2): http://static.norgesbank.no/pages/104006/FinancialStability_2015.pdf?v=11/12/201512811PM&ft=.pdf
–
Monetary Report 1/16 (chapter 3): http://static.norges-bank.no/pages/104770/MPR_1_16.pdf?v=3/17/201620125PM&ft=.pdf
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FINANCIAL STABILITY
HENRIK BORCHGREVINK
UIO
APRIL 22 2016