New Norwegian measures ‘ensure capital retention’

New measures announced by the Norwegian Ministry of Finance for how banks calculate capital requirements for mortgage loans under the IRB approach are credit positive because they ensure retention of capital, Moody’s said on Monday.

The rating agency said the finance ministry on 14 October increased from 10% to 20% for mortgage loans the minimum loss given default (LGD) parameter used to calculate banks’ Basel II capital requirements under the internal ratings-based approach (IRB). The ministry also signalled that the prevailing Basel I transitional floors, which limit the extent to which bank capital ratios improve owing to lower risk weights, will not be removed until mortgage risk weights are increased to the current level including the transitional floors, said Moody’s.

Increasing the LGD for residential mortgages to 20% means that the average risk weight on mortgages would increase to around 20% under IRB from a prevailing average of 10%-13%, according to Moody’s

To ensure that domestic banks are not placed at a competitive disadvantage relative to branches of foreign banks operating in Norway, the minimum requirement will also apply to branches of foreign banks, noted the rating agency. The amendment comes into force on 1 January 2014.

Moody’s said that the measure will strengthen the robustness of banks’ internal models, although the effect on banks’ capital ratios will be modest because the ministry has said that Basel 1 transitional floors will remain in place until the end of 2017, with the possibility of further extension. The transitional floor limits the reduction in the risk weighted assets to 80% of the Basel 1 capital requirement.

The rating agency noted that the Norwegian Financial Services Authority (Finanstilsynet) will continue to assess banks’ internal models with the aim of setting the future minimum mortgage risk weights at a higher level. According to Moody’s, Finanstilsynet considers that the LGD needs to be increased to at least 43% to ensure the retention of capital after the removal of transitional floors, which implies the possibility of future regulatory changes.

“The retention of transitional floors and further focus on risk weights for residential mortgages is credit positive for Norwegian banks because it ensures the retention of capital,” said Moody’s. “Moreover, increasing regulatory oversight of mortgage risk weights would help control loan growth and could help curb house price appreciation.”

According to the rating agency, eight Norwegian banks out of nearly 150 use the advanced IRB approach for calculating capital requirements: DNB Bank, Nordea Bank Norge, Sparebank 1 SR-Bank, Sparebanken Vest, Sparebank 1 Nord-Norge, Sparebank 1 SMN, Bank 1 Oslo Akershus, and Sparebanken Hedmark.