Norway Cracks Down on Mortgage Debt to Fight Bubble Risk

Norway’s financial regulator is throwing its weight behind a government proposal to force banks to assign higher loss probabilities to mortgage assets as the nation looks for ways to cool its overheated property market.

The Financial Supervisory Authority in Oslo will add stricter risk-weight recommendations to a raft of measures, including curbs on covered bond issuance, all designed to prevent a repeat of the 1990s crisis that sent Norway’s real estate prices plunging 40 percent and left households with unsustainable debt loads.

“The FSA shares the ministry’s concern for household indebtedness and soaring house prices,” Morten Baltzersen, who heads the watchdog, said yesterday in a telephone interview. “We agree with the ministry that the risk weights on house loans need to be increased.”

The Finance Ministry in December proposed tripling risk weights to 35 percent, more than double the recommendation in neighboring Sweden, after Norwegian house prices and private debt burdens soared to records. The FSA’s response signals banks should start adjusting to the stricter requirements, now that the measures have won both government and regulatory backing.

House prices in Western Europe’s biggest oil exporter have doubled since 2002, and rose an annual 8.5 percent last month, according to the Norwegian Association of Real Estate Agents. At the same time, household debt will swell to more than 200 percent of disposable incomes this year, the central bank estimates. In the years leading up to the 1990s bubble, the debt ratio reached about 150 percent.

Rich Countries

As central banks in the U.S., Japan and the euro area keep interest rates at unprecedented lows to aid growth, some of the world’s richest countries like Norway, Switzerland and Sweden are battling overheated housing markets fueled by cheap money. Norway’s central bank has kept its main rate at 1.5 percent since March last year as policy makers try to balance an overheated housing market against keeping krone gains in check.

Low interest rates have contributed to imbalances in the housing market that the FSA says can’t go unfettered any longer. Banks’ internal risk models have also failed to capture the threat of losses that the development has caused, according to the regulator.

“We endorse the Finance Ministry’s view that risk weights in the banks’ internal risk models do not sufficiently capture the underlying relevant risk on residential mortgage lending, particularly the systemic risk involved,” Baltzersen said.

Already Adapting

DNB ASA, Norway’s biggest bank, is already adapting to the stricter requirements. The lender says it has set aside 53 billion kroner ($9.3 billion) in additional reserves in the past five years and is aware the FSA wants it to raise more capital.

Higher risk weights mean the price of mortgages will rise, Thomas Midteide, a spokesman at DNB, said in an e-mailed reply to questions.

“The question is no longer if the banks will increase margins, but when,” Midteide said. “We have not set a date for an increase on mortgage margins. But we have to plan measures now to adapt to the proposals.”

Nordea Bank AB sees a 3 billion-euro ($3.9 billion) impact on its risk-weighted assets stemming from Norway’s new mortgage risk weights, according to a presentation published on its website today.

Risk weights on mortgage loans in Norway are currently 11 percent, under Basel II rules. That compares with 15 percent in Germany and as high as 35 percent in Spain, according to data provided by Sweden’s central bank. A 35 percent floor would be the highest in the Nordic region.

Await Outcome

Baltzersen said the government should await the outcome of European legislation based on Basel III, known as the Capital Requirements Directive IV, before committing to a risk-weight level. The ministry plans to send a proposal on mortgage lending rules for a hearing this month.

The FSA this week also endorsed the ministry’s plan to limit banks’ use of covered bonds to finance mortgages. The regulator said it evaluated “qualitative” rules on shifting loans to covered bonds and that oversight is best done on a bank-by-bank basis.

Norwegian banks’ reliance on offshore funding is another source of concern, Baltzersen said. At the end of October, about 77 percent of bank funding stemmed from foreign sources, amounting to 1.08 trillion kroner, Statistics Norway data show.

Banks “are to a large extent reliant on wholesale market funding in foreign markets. The experience from the last years’ turmoil in international money and capital markets underlines the importance of making the market funding more robust,” Baltzersen said. While “the market funding has become more resilient, Norwegian banks should continue their efforts to make their market funding even less vulnerable.”

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