Norway will disregard a recommendation by its central bank and, for now, give its financial industry some freedom to decide how to meet liquidity rules for krone liabilities.
The supply of kroner is probably too small for stricter requirements to be feasible without causing market distortions, according to Tore Vamraak, state secretary to the Finance Ministry in Oslo.
“A general minimum requirement in kroner may lead to reduced liquidity in the market as banks ‘lock up’ a larger portfolio of outstanding bonds,” Vamraak said in an e-mailed response to questions regarding a Nov. 25 ministry statement. By allowing the banks to fulfill the liquidity coverage ratio requirement with bonds denominated in other currencies, “they obtain a more diversified and liquid buffer,” he said.
Norway’s biggest banks, led by by DNB ASA, hold only a small portion of their liquidity buffers in kroner. The central bank wants the minimum requirement to be set at 60 percent of liquid assets denominated in kroner, which it says is a threshold that takes into account the limited volume of Norway’s currency.
But setting the requirement too high risks creating instability rather than relieving it, according to the Finance Ministry.
The Financial Supervisory Authority may impose requirements on a case by case basis, Vamraak said. But setting a general minimum rule risks leading to unintended consequences. Those could include incentives to issue more covered bonds; it may also lead to an “increased contagion risk between banks as they buy each other’s bonds,” he said, citing concerns raised by the regulator.
Under European Union rules that went into effect last month, banks must begin building buffers of highly liquid assets that can be sold off quickly if markets become stressed. Banks need to be able to demonstrate that they have adequate reserves to withstand a 30-day freeze in the markets.
Norway’s financial industry, which is dominated by DNB and Nordea, however, should be exempted from a currency matching requirement because of the small supply of krone-denominated assets, the European Banking Authority has said. Liquidity requirements would exceed the amount available in Norway’s krone market by 63 percent, according to the EBA. The commission hasn’t voted yet on the recommendation.
Norway’s Finance Ministry published a note on Nov. 25 in which it set out new liquidity rules to ensure its banks are aligned with lenders across the Europe. Norway, which isn’t an EU member, will require its systemically important banks -- DNB, Nordea and Kommunalbanken -- to hold liquidity reserves equal to 100 percent of their exposures by the end of the year.
The ministry is requiring banks to report what portion of their krone-denominated liabilities is covered by liquid assets denominated in kroner. The FSA will use the information to assess by next year whether a minimum level may be necessary, Vamraak said.