The watchdog overseeing banks in western Europe’s biggest oil exporter says Norway’s financial industry may still be underestimating the risk of losses, even after a 70 percent recovery in crude prices since January.
The Financial Supervisory Authority is comparing corporate risk weights that banks in Norway calculate using an internal ratings-based approach, or IRB, against data to identify lenders that are potentially holding insufficient capital against future losses, according to Emil Steffensen, deputy director general at the Oslo-based agency.
“We are addressing what we think is a downward slide for some banks,” Steffensen said by phone. “Our main concern is that IRB models should not give too low a capital requirement” and instead have a “necessary forward-looking perspective.”
Norway’s FSA has told lenders it expects them to take more impairments to reflect the shock to the economy of the new level of oil prices. Brent crude traded at $115 a barrel in June 2014. One barrel cost about $48 on Thursday.
“When you have weaker growth or a setback in an industry, it takes in general some time before you see losses coming through,” Steffensen said. Banks already have eased credit standards for some corporate clients, and are therefore “obliged to make an assessment of the need for provisioning when they give some sort of repayment releases.”
“We expect provisions to increase,” Steffensen said. The recent increase in oil prices “is minor and will not affect things significantly. If oil goes back to 100, that’s something else.”
The FSA’s focus on corporate exposures is part of a broader effort to address gaps in risk models. They’re based largely on historical data and as a result they may not be good enough predictors of future losses, the agency has warned. It has already more than doubled risk weights on mortgages as household debt climbs to record highs.
Retail loans account for half of bank lending, while loans to companies outside the oil and property markets make up 29 percent, according to FSA data. Oil-related lending comprises 5 percent of bank loan books.
The FSA plans next year to use the results of stress tests to provide banks with guidance on how much capital they should hold, above minimum European and national, or Pillar 2, requirements.
“The FSA is using, and has been using, stress tests as an input into the assessment of Pillar 2 requirements,” Steffensen said. “Next year, we will do this in a more strict manner following the development of our stress testing methodology.”
Norway continues to support banks’ use of internal models to gauge risk and set capital levels, flaws in the approach notwithstanding, Steffensen said. Amid concern that banks are designing models to cut their capital needs, the Basel Committee on Banking Supervision has proposed floors.
“We are not for dismissing IRB models,” Steffensen said. “You can use IRB models but you have to be very careful in checking the output of these models, in addition to having effective backstops.”
Among those is a sufficiently high leverage ratio, which is a measure of capital against unweighted assets. Norway has proposed a ratio of 3 percent for its mortgage lenders and 6 percent — twice the minimum set by Basel — for its banks. The Ministry of Finance is expected to set the level in the second half of this year.
“Three percent is too low,” Steffensen said. “There should not be a close-to-zero risk of breaching the leverage ratio.”