Tuesday, December 18, 2012

Sweden and Norway show how hard it is for regulators to 'lean against the wind' of rising asset prices

In response to the current financial crisis, financial regulators said that they have learned their lesson and in the future they will 'lean against the wind' in the face of rapid asset price increases.

To ensure the financial regulators do this, in the US we saw the introduction of the Financial Stability Oversight Council and in the UK we saw the introduction of the Financial Policy Committee.

A Bloomberg article on Sweden and Norway shows how hard it will be for regulators to successfully lean against the wind.

The article supports the Nyberg Report on the Irish Financial Crisis conclusion:  regulators, particularly individuals who work inside the regulators, are isolated and find it hard to act when they want to lean against the wind against rising asset prices as these higher prices are supported by politicians, bankers and society.

Sweden and Norway say their banks have underestimated the risk in their mortgage portfolios and will need to set aside more capital to guard against losses as the two nations move to stop debt bubbles forming.
Norway’s government said yesterday it wants to triple the risk weights assigned to mortgage assets, bringing the minimum requirement to 35 percent. That followed a similar decision in neighboring Sweden, where the regulator on Nov. 26 set the minimum risk-weight requirement at 15 percent, almost three times existing levels. 
As central banks respond to the crisis in Europe with interest rate cuts, households are amassing record amounts of debt.
Is this an unintended or intended consequence of central bank policy?
In Norway, the world’s fourth-richest nation per capita, private debt will swell to more than 200 percent of disposable incomes next year, while Sweden’s debt load hit a record 173 percent this year, the countries’ central banks estimate. 
That’s putting pressure on regulators to ensure banks have buffers that can withstand sudden adjustments in asset prices. 
“There is a substantial risk that there is a housing bubble” in Norway, Harald Magnus Andreassen, chief economist at Swedbank First Securities in Oslo, said in a phone interview. “If you look at a graph, you would be quite confident that something could be wrong.”

House prices in Norway have doubled since 2002 to reach a record, according to the Norwegian Association of Real Estate Agents. Sweden’s National Housing Board has warned that the property market in the largest Nordic economy is in the grip of a bubble. 
Bengt Hansson, an analyst at the board, estimates Swedish house prices are 20 percent overvalued, adjusting for the effect of inflation. 
“This is based on an optimism regarding rising prices in the future and low interest rates in combination with very generous lending policies,” Hansson said by phone yesterday. 
Yet banks argue that stricter capital and risk-weight rules will put them at a competitive disadvantage relative to their rivals elsewhere in Europe....
Notice how the banks are pushing back even though household debt is at record levels and house prices appear to be over-valued.
Risk weights, as defined by Basel II regulations, on mortgage loans in Norway are now 11 percent, compared with 15 percent in Germany and as high as 35 percent in Spain, according to data provided by Sweden’s central bank. Norway’s proposed 35 percent floor would be the highest in the Nordic region. 
Raising risk weights to 15 percent in Sweden would force the largest banks there to set aside an additional 20 billion kronor ($3 billion) in capital, the FSA estimates. Norway’s regulator hasn’t provided estimates for the cost to its banks....
Any how will the banks respond to possibly needing more capital?
Lenders will respond by raising customer rates, Jan Digranes, head of the banking and capital markets department at Finance Norway, which represents about 180 financial institutions, said by phone from Oslo. “Banks have to increase interest rates to increase net earnings and they will have to discuss whether it will be necessary to issue more capital to comply with the new requirements.” 
DNB ASA (DNB), Norway’s biggest bank, hasn’t changed its financial targets based on yesterday’s announcement. The government’s proposal, which the regulator is due to follow up on in March, sets risk weights “too high,” DNB spokesman Thomas Midteide said in an e-mailed reply to questions.
By lobbying against the increase and by keeping the interest rate on loans high even when the central bank lowers rates as Sweden's did yesterday.
Both Sweden and Norway are pushing stricter regulatory requirements after enduring a banking meltdown in the 1990s. ... 
Household debt levels now are even higher than they were at their peak back then, according to Michael Wolf, chief executive officer of Sweden’s largest mortgage lender Swedbank AB. Wolf said in a Dec. 4 interview that Sweden’s housing market probably faces “some sort of adjustment.” 
Household debt levels in Norway and Sweden have continued to rise even after both countries introduced an 85 percent cap on loans relative to property values. 
That’s spurred discussion among central bankers on the extent to which monetary policy should be deployed to curb housing-market imbalances. Swedish central bank Governor Stefan Ingves, who is also the chairman of the Basel Committee, has argued in favor of using policy interest rates to stem the threat of housing bubbles. 
Yet Ingves, like his counterparts elsewhere in Europe, is finding his freedom to raise rates curtailed by the fallout of the debt crisis further south. His bank cut its main rate today by a quarter point to 1 percent. 
Policy makers in Norway and Sweden need to decide whether the imbalances in their housing markets are temporary or long term. That could guide them to the right response, according to Andreassen at Swedbank. 
“Risk weighting is more a structural argument, in the sense that if it is too cheap for banks to extend credit to housing then you have a risk at all times to have too much debt,” he said. “Usually you would think of the interest rate as a business cycle adjustment.”

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