Norway Seeks to Stem Covered Bond Issuance to Curb Bank Risk

Norway’s Finance Ministry is seeking to set limits on the amount of loans banks can transfer to their mortgage units to back covered bonds as part of an effort to prevent a build-up of risk amid a potential property bubble.

The ministry has asked the financial regulator to set a “qualitative” rule on loan transfers to wholly owned mortgage units, according to letters to the Financial Supervisory Authority and the central bank published today. There may be a need for rules that allow the FSA to demand extra capital at a bank if there’s a considerable increase in risk from shifting loans to credit units, the ministry said.

The proposals follow an October recommendation from the FSA that consideration should be given to introducing limits on the proportion of assets that can be posted as collateral for covered bonds. The use of mortgage loans to secure the bonds means less high-quality assets are left on the banks’ balance sheet, while the low funding costs of covered bonds risk drawing away financing from other areas, the watchdog said at the time.

Near-record low interest rates in the world’s fourth-richest nation per capita, coupled with falling unemployment and solid wage increases has fueled household credit growth, pushing private debt levels and house prices to records. Norway, which is western Europe’s largest petroleum exporter, has withstood the euro area debt crisis thanks to its oil wealth.

Putting Responsibility

House prices have risen 7.6 percent this year, while private debt levels will rise to more than 200 percent of disposable income next year, according to central bank estimates. The FSA has warned that the run-away housing market represents the biggest domestic threat to the economy.

“Essentially the government is putting the responsibility for slowing lending growth and stabilize household debt levels on banks rather than Norges Bank,” said Erica Blomgren, chief strategist at SEB AB in Oslo. “By both limiting banks’ ability to issue covered bonds and making it more expensive by demanding banks to hold more equity for issuance of covered bonds, the cost for mortgages will increase.”

The government this week also proposed to raise risk weights on mortgage loans, to further ease lending growth. The ministry today said that the FSA should examine whether banks may need to reduce their economic ties to their mortgage lending units. It also said the regulator and central bank should look into whether credit units that issue covered bonds should have restricted bank concessions limited to mortgage lending.

The ministry said it was up to the central bank to decide whether it will lend to issuers of covered bonds. The FSA will prepare a report on the ministry’s proposals by March 1.

“The balance sheet encumbrance issue is not really new and has been discussed by the Norwegian and Swedish regulators for the last year,” Hakon Fure, an analyst at DNB ASA in Oslo, said in an e-mailed response to questions today. “I do not expect any quantitative rules limiting the use of covered bonds or imposing minimum deposit-to-loan ratios, but rather expect qualitative rules regarding the risks transferred. Thus, I do not expect this to be a big issue.”

DNB ASA, Norway’s largest lender, rose 1.15 kroner, or 1.65 percent, to 70.75 kroner at 10:53 a.m. in Oslo today.

Norway’s covered bond market has grown to about 780 billion kroner ($137 billion) from less than 100 billion kroner in 2007 and makes up about 20 percent of the banks’ funding, the FSA said in October.

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