The Financial Crisis – the Path Ahead

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The Financial Crisis the Path The Financial Crisis – the Path Ahead

Governor Svein Gjedrem

The Norwegian Savings Banks Association’s The Norwegian Savings Banks Association s Annual Meeting, Stavanger

22 October 2009

”Through both of these years, 1921 and 1922, ceaseless efforts had been made week after week to resolve a wretched situation.

There was a constant stream of worries one There was a constant stream of worries, one thing after another, one disheartening report after another, and minor setbacks were followed by major setbacks. It was reminiscent of an operating theatre. The task was onerous not only because of its

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was onerous not only because of its proportions, but also because of the oppressive weight of the anxiety that accompanied it.” Nicolai Rygg

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” The greatest risk lay in the fact that this anxiety had now become pervasive. The very foundations of confidence, the nation’s confidence in its own credit institutions had been shaken … The most important objective was therefore to prevent an avalanche, seek to contain the damage, hang on and hold back. That was the dominant thought, to prevent total collapse, for the danger of this was indeed present… and the general atmosphere of nervousness manifested itself in the most peculiar

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nervousness manifested itself in the most peculiar ways. In the blind panic that ensued, attacks were made on institutions that were more than deserving of their depositors’ confidence.”

Nicolai Rygg

” In the context of the current crisis the surprise was not the decline in real estate prices or the fact that subprime mortgages were the first to be affected by this decline. Rather, the surprisey p was in the distress of many parts of the financial system, even those very distant from the subprime market itself, including all structured products, commercial paper, and interbank lending. At a moment’s notice, linkages becameg g too complex and hard to understand, … and panic ensued.”

Ricardo J. Caballero og Pablo Kurlat (2009)

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Norwegian banks’

¹⁾

gross stock of non- performing loans

Percentage of gross lending to sectors . 90 Q3 – 09 Q2

12 14 12

14

All sectors

4 6 8 10 12

Households Enterprises

0 2 0

2

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: Norges Bank

5

1)All banks in Norway

Unemployment

Per cent. Seasonally adjusted. January 1990 – August 2009

8 9 8

9

LFS unemployment

3 4 5 6 7 8

Registered unemployed Registered unemployed and on labour market programmes

1 2 1

2

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Sources: Statistics Norway and NAV

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Proposals to strengthen banks’

capital base and liquidity

Higher capital adequacy requirement and new minimum equity capital ratio requirement minimum equity capital ratio requirement

Strengthen quality of Tier 1 capital

Build up buffers in good times that can be drawn on in periods of stress

Regulation of systemically important banks t i t th f th b k

more stringent than for other banks

Increased and improved liquidity

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Norwegian banks’

¹⁾

Tier 1 capital ratio

Per cent. 93 Q1– 09 Q2

12 14 16

Tier 1 capital ratio

2 4 6 8 10 12

2 4 6 8 10

12 Minimum requirements

0 0

1993 1995 1997 1999 2001 2003 2005 2007 2009

1)All banks in Norway except branches of foreign banks

Source: Norges Bank

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Bank equity capital

Percentage of total assets. 1875 – 2009¹⁾

20 20

5 10 15

0 0

1875 1895 1915 1935 1955 1975 1995

Sources: Klovland (2007), Statistics Norway and Norges Bank

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1)Figures as of 2009 Q2

Norwegian banks’¹⁾ equity capital as a percentage of total assets and Tier 1 capital ratio

Per cent. 30 June 2009

Source: Norges Bank 10 1) All banks except branches of foreign banks in Norway

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10 12 10

12

Perpetual capital securities

Norwegian banks’

¹⁾

Tier 1 capital

Percentage of risk-weighted assets

0 2 4 6 8

0 2 4 6

8 Preference capital

Common equity

Deductions for goodwill, etc.

-2 0 -2

0

2009 Q2 Including new issuance in the

market

Plus capital from the State Finance

Fund

Net Tier 1 capital ratio

1)All banks except branches of foreign banks in Norway

11 Sources: The Financial Supervisory Authority of Norway , the State Finance Fund and Norges Bank

Macroprudential Microprudential Proximate objective Limit financial system-

wide distress

Limit distress of individual institutions

The macro- and microprudential perspectives

wide distress institutions Ultimate objective Avoid output (GDP)

costs linked to financial instability

Consumer

(investor/depositor) protection

Correlations and common exposures across institutions

Important Irrelevant

institutions

Source: ”Addressing Financial System Procyclicality: a Possible Framework”, Note for the FSF Working Group on Market and Institutional Resilience, Bank for International Settlements, 1 Sep 2008

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House prices in selected countries

Index. 95 Q1=100. 95 Q1 - 09 Q3

350 400 350

400

Norway US UK

100 150 200 250 300 350

0 50 0

50

1995 1997 1999 2001 2003 2005 2007 2009

Sources: Thomson Reuters, Association of Norwegian Real Estate Agents, Association of Real Estate Agency Firms, FINN.no, ECON Pöyry and Norges Bank

“…(on) October 10, the G-7 met and agreed the following plan of action:

“Take decisive action and use all available tools to support systemically important

financial institutions and prevent their failure.”

Communiqué of the International Monetary and Financial Committee of the Board of Governors of the International

Monetary Fund, October 11, 2008

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Banks’

¹⁾

assets in billions of NOK and Tier 1 capital ratio in per cent

As of 30 June 2009

Source: Norges Bank 15 1) All banks except branches of foreign banks in Norway

Moody’s on DnB NOR Bank’s rating

“... the bank's debt and deposit ratings

continue to benefit from a three notch uplift continue to benefit from a three-notch uplift from the BCA [Baseline Credit Assessment], which reflects the bank's systemic

importance in the Norwegian banking sector as well as the part ownership by the

government Therefore the ratings government. Therefore, the ratings incorporate a very high probability of systemic support.“

Source: Moody’s, 8 Sep 2009

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2,5 2,5

Risk premiums on Norwegian senior bank bonds

Compared with swap rates. Percentage points. Week 1 05 – week 42 09

0 5 1,0 1,5 2,0

DnB NOR Bank (rated AA) Smaller banks rated A 1)

0,0 0,5

2005 2006 2007 2008 2009

Source: DnB NOR Markets

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1)Banks with assets between NOK 5bn and 15bn and which are rated A by DnB NOR Markets

Minimum Tier 1 capital requirements in a downturn.¹⁾

Calculations with a short and long data basis. In billions of NOK

200 200

50 100 150

0 50

2008 2009 2010 2011

Basel I Basel II 1 year

Basel II 5-year moving average Basel II 20-year moving average

Source: Norges Bank

Year 0 Year 1 Year 2 Year 3

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1)The five largest Norwegian banks and Nordea Bank Norge

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50 50

Foreign owned

Domestic credit to enterprises from banks and mortgage companies in Norway

12-month rise. Per cent. January 2006 – August 2009

10 20 30 40

Foreign-owned

Norwegian-owned

19

0 10 0

10

2006 2007 2008 2009

Source: Norges Bank

Funding sources for Norwegian banks

¹⁾

Percentage of total assets. 1975 – 2009²⁾

100 100

Equity

40 60 80

Deposits

Loans from Norges Bank

Swap arrangement 2)

0 20

1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008

Market financing and other debt

Sources: Klovland (2007), Matre (1992), Statistics Norway and Norges Bank

1)09 Q2

2)The swap arrangement is registered in the banks’ balances as debt to the government

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150 180 150

180

Outstanding covered bonds

Percentage of GDP. End of 2008

30 60 90 120 150

Backed by other loans Backed by mortgages

0 0

Denmark Germany Spain Sweden Norway 1)

Sources: European Covered Bond Council, Statistics Norway and IMF 21

1)June 09 for Norway

Flexible inflation targeting

The operationaltarget of monetary policy shall be annual consumer price inflation of approximately 2.5 per cent over time

over time.

Norges Bank operates a flexible inflation targeting regime, so that weight is given to variability in inflation as well as to variability in output and employment.

Norges Bank’s interest rate setting follows areaction Norges Bank s interest rate setting follows a reaction

function

Key policy rate = function of all factors influencing inflation and output

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110 150 110

150

Norges Bank's liquidity supply Structural liquidity

Projections

Bank liquidity

In billions of NOK. 1 January 2007 – 31 December 2009¹⁾

-50 -10 30 70

-50 -10 30

70 Bank deposits in Norges Bank

-130 -90 -130

-90

2007 2008 2009

Source: Norges Bank

1)Projections from 19 October 2009

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0 8 1,0 0 8

1,0

Minimum price in the government swap

Risk premiums on Norwegian covered bonds

Compared with swap rates. Percentage points. Week 1 08 – week 43 09

0,0 0,2 0,4 0,6 0,8

0,0 0,2 0,4 0,6

0,8 government swap arrangement

3-year maturity in the market

5-year maturity in the market

-0,4 -0,2 -0,4

-0,2

Jan-08 Jul-08 Jan-09 Jul-09

Sources: DnB NOR Markets and Norges Bank

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Changes in collateral for loans in Norges Bank

New securities under the temporary rules will not be

approved as collateral as from 22 October 2009

Securities already approved under the temporary

Securities already approved under the temporary rules may be pledged as collateral until maturity, at the latest until 15 February 2012

Debt instruments issued by foreign banks are

included in the bank quota as from 1 December 2010

S iti i d b b k ill l b li ibl

Securities issued by banks will no longer be eligible as collateral for loans from 15 February 2012

Norges Bank will continue to accept covered bonds (OMF) as collateral for loans

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Bankruptcy rate during and following banking crises in Norway

Per cent

0 8 0,9 1

The banking crisis 1988-1993 The dotcom crisis

0 2 0,3 0,4 0,5 0,6 0,7 0,8

0 2 0,3 0,4 0,5 0,6 0,7

0,8 The dotcom crisis The financial crisis

0 0,1 0,2

t=0 t=2 t=4 t=6 t=8 t=10 t=12 t=14 t=16 t=18 t=20 t=22 t=24

26 Sources: Statistics Norway and Norges Bank T=0 is defined as the latest pre-crisis quarter when the bankruptcy rate was at its lowest level

1)Projections from 2009 Q3