Leverage Under Attack at Norway's Banks as FSA Trounces Basel

Norway’s financial regulator is telling the banks it oversees to gird for even tougher capital requirements as it looks for ways to cut the industry’s reliance on leverage.

The Financial Supervisory Authority in Oslo wants banks to hold more than twice as much capital against total assets as would be required under Basel III proposals. The so-called leverage rule is intended to counter industry efforts to rely on questionable risk weights to lighten their capital burdens.

Though the FSA says its requirement doesn’t represent a target as such, it wants banks to be aware it expects their equity capital ratios “should improve further, and that improvement shall not take place in the form of lower risk-weighted assets but by an increased numerator,” Morten Baltzersen, the FSA’s director general, said in an interview. “The numerator should increase more than the total assets.”

Stricter regulatory demands have already taken their toll, according to Karl Morris, an analyst at Keefe, Bruyette & Woods. Requirements for DNB, Norway’s largest lender, already “have gone up by 150 basis points, which has been a big negative,” Morris said.

Norwegian banks’ leverage ratio averaged 6.7 percent at the end of June, according to FSA data. That compares with a non-binding leverage ratio of 3 percent that the Basel Committee on Banking Supervision is testing before it becomes a binding requirement by 2018.

Baltzersen says Norway’s banks need to do more to guard against risks stemming from an overheated property market. Risk weights on mortgage assets, which in Norway are calculated using internal ratings-based models, are currently influenced by “more than 20 years of benign development,” he said. The FSA has already introduced measures to improve risk weighting, including stricter rules on setting default probabilities.

“We have been very concerned to avoid IRB models pushing risk-weighted assets too far down,” Baltzersen said. “Having said that, we emphasize that capital requirements should basically be risk sensitive.”

Norway’s house prices have soared to record levels after the central bank cut rates to historic lows to protect the economy of western Europe’s biggest crude producer from the fallout of plunging oil prices. The development has driven household debt to record levels that the central bank and regulator warn are unsustainable.

The FSA is also cautioning banks against paying out generous shareholder rewards. DNB paid 30 percent in dividends from its 2014 profit, according to its full-year report. The bank has set itself a long-term goal of paying more than half its profits to shareholders.

DNB said at its capital markets day that it will hit that target in 2017 at the latest. The bank also plans to have by the end of that year a core equity Tier 1 capital ratio of 15.5 percent, including a management buffer. It said it will lower its cost-to-income ratio below 40 percent.

Shares in DNB rose as much as 2.6 percent. The stock gained 2.2 percent to 113.20 kroner at 1 p.m. in Oslo on trading volume that was 86 percent of the three-month daily average.

Banks should “increase the capital and to do this they should have moderate dividend policies in order to retain the bulk of the good profits they are earning,” Baltzersen said.

But there are concerns that raising leverage ratios beyond a certain point risks triggering the law of diminishing returns. Research by the European Central Bank shows that limiting leverage will create more stable banks, but that if ratios are set too high, the benefit starts to fade.

Given the regulatory developments in Norway, bank investors are starting to wonder what’s in store. Finans Norge, Norway’s bankers association, will next year head to London to hold its first capital markets day to address the concerns.

Banks “come back and tell us that all investors, all market participants in London and other places, have a lot of questions about how and why the Norwegian authorities do as they do,” said Jan Digranes, head of banking policy at Finans Norge. “What are their inventions? What do they mean?”

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