Co-published Covered bonds guide: Norway


• the need for a “qualitative” rule limiting covered bond issuance by banks;


• the economic ties between banks and SCBIs; and


• an assessment of whether SCBIs should be allowed to borrow from Norges Bank on the basis of a restricted banking licence. The final replies from FSAN and Norges


Bank were published this spring and while they agree that there are some concerns they do not recommend significant changes from current legislation.


Limitations on covered bond issuance The issuance of regulated covered bonds in Norway was introduced as late as 2007 and has achieved a great deal of success in a short time. In some ways covered bonds got off to a quick start due to the 2008 financial crisis. In order to inject liquidity into the banking system the government introduced a programme swapping treasury bills for covered bonds backed by Norwegian mortgages. This resulted in the issuance of around NOK 230 billion in covered bonds. Covered bond issuance has lowered financing costs, diversified the financing structure of the banking system and played an important role in allowing the Norwegian banking system to maintain relatively normal lending practices during the financial crisis. As of 2013 there are NOK 800 billion of outstanding covered bonds and DNB, the largest Norwegian bank, has issued NOK 522 billion in covered bonds involving the transfer of 86% of its home mortgages to SCBIs. Overall Norwegian banks have transferred on average 60% of their home mortgages to SCBIs. The FSAN has pointed to several concerns


arising from such high levels of asset collateralisation including: • reduced flexibility for the banks in any future liquidity crisis;


• procyclicality as banks are incentivised to issue mortgages ;


• transferring assets to an SCBI results in a structural subordination of the banks’ unsecured creditors and in the event of a default depositors will have a smaller pool of unencumbered and possibly lower quality assets securing their claims.


Norges Bank also pointed to the problem


that investor expectations of a government guarantee for systemically important banks, such as DNB, may mean that investors do not seek compensation in the form of higher returns even when there is a high proportion of encumbered assets. This would further skew the banks’ incentives to issue covered bonds. Despite these concerns the FSAN concluded that a general limitation on the ability of banks to issue covered bonds, and


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thereby encumber their assets, would not be the best approach to addressing these concerns. According to the FSAN banks and banking


groups should be assessed individually taking into account the different banks’ sizes and their different ownership, financing and portfolio structures. The FSAN therefore concluded that the issue of encumbered assets should be a part of the FSAN’s regular monitoring of the bank’s own risk assessments under the second pillar (Supervisory review) of Basel II. Such risk assessments and stress tests are expected to identify and respond to any risk related to asset encumbrance. The FSAN’s role will be to assess the banks’ own risk management. The FSAN does, however see a greater need for attention to the issue of overencumbrance in the banks’ Internal Capital Adequacy Process (ICAAP) and Supervisory Review and Evaluation Processes (SREP). This approach is in line with the recommendations of the European Systemic Risk Board. As a part of their review the FSAN


considered the need for new regulations allowing the FSAN to impose stricter capital requirements on banks that, despite their internal controls, have increased their risk profile in part due to overencumbrance. The FSAN concluded that it already had the authority to require bank’s to adjust their activities if they transfer too many mortgages to their SCBI. The FSAN also evaluated the need for


greater transparency with regard to asset encumbrance in order for both covered bond investors and unsecured creditors of the bank to assess the quality of underlying assets. This time the FSAN concluded that increased information was required and indicated that requirements would be issued either as a regulation or an FSAN circular.


Linkage between Sponsor Banks and SCBIs As discussed in Part I there is a close link between SCBIs and their Sponsor Bank(s), including credit facilities given by the Sponsor Bank with very few restrictions. These credit facilities are in part intended to give the SCBI a higher rating from the credit rating agencies by allowing for “credit substitution”, which is a linkage between the rating of the bank and the rating of the SCBI. The FSAN considered these linkages but concluded that they would not at this time propose any limitations on banks’ ability to provide credit facilities or guarantees to their SCBIs. Such facilities were considered important in order to allow the SCBI’s to issue covered bonds with high quality assets and the FSAN emphasized instead the


importance of monitoring and transparency as discussed above.


Central bank lending The final part of the FSAN/Norges Bank review considered whether SCBIs should be granted a restricted banking licence that would give them access to the central bank’s lending facilities. A primary motivation for this proposal is that such access to the central bank’s lending facilities would allow for reduced financial ties between the Sponsor Bank and the SCBI. Both FSAN and Norges Bank were


negative to this proposal, albeit for partly different reasons. FSAN was sceptical to changing the definition of a bank to include institutions that do not accept deposit from the general public and proposed that any such change would require a broader review of any additional consequences other than giving SCBIs access to central bank lending. Norges Bank was very much opposed to


the proposal based on the principle that the central bank’s liquidity facilities are not intended to limit an individual institution’s liquidity risk or function as a funding source but are instruments designed to implement monetary policy and payment settlement. Norges Bank argued that SCBIs with a restricted banking license would neither accept retail deposits nor execute retail payments and their role in liquidity redistribution in the money market would therefore probably be limited. Both FSAN and Norges Bank also pointed out that the central bank already had the authority to make loans to other entities than banks in situations where, in the opinion of Norges Bank, financial stability may be threatened if such support is not provided. Norges Bank declined to provide any further information on when such lending may occur stating that it is “neither possible nor desirable” to predefine such situations.


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IFLR/July/August 2013 65


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