Policy Measures to ease access to funding

Thank you, Mr. Chairman!

Let me start by thanking Bloomberg for giving me this opportunity to take part in this discussion on the financial crisis. Since the other speakers have described the background for the crises in a excellent way; I will in my presentation focus on the role of and actions taken by the authorities. Also putting the Norwegian measures in an international perspective.

The risk premium in the US bond market at February 8th, was close to 6 per cent. All over the world only the most creditworthy companies have been able to raise new debt in the market at acceptable terms. We have to go back to the depression in the 30ies to find a similar situation in the US bond market as we presently see.

September 15th 2008 when Lehman Brothers went bankrupt, will mark a turning point in economic history.  The uncertainty increased strongly, and there was close to full stop in the money and credit markets.

In the following months, uncertainty and fear characterized the financial markets. Willingness to lend money among market participants, and the access to funding in the international financial markets was switched off in mistrust.

Swift and decisive policy actions prevented a full collapse of the financial system. The functioning of the money markets is now better and the risk spreads have been reduced.

However, despite strong policy actions from the authorities, market conditions are far from normal, and the uncertainty is still pronounced. It becomes more and more clear that the crises have contributed to an extremely strong and prolonged international downturn, with a more and more negative outlook for world economy every month. The chances for a quick recovery are reduced day by day.

The financial crises and weaker international growth also affects Norway. Norwegian authorities have done much to improve the situation. The list of action taken is quite comprehensive. These are measures that will benefit industry and households all over the country. However, growth prospects are significantly downward adjusted for 2009 also for Norway, but to a less extent than in most other countries. Our latest forecast are zero growth in the Mainland economy in 2009, or maybe slightly below that. This is weak, but substantially higher than the average for the OECD countries.

 

Measures taken in other countries
Measures have been carried out internationally to prevent even more serious consequences of the financial crises on the real economy and the financial system.

The first line of defense has been monetary policy. Central bank interest rates have been significantly reduced, in some countries to a level close to zero. Central banks have increased the supply of liquidity to dampen the effects from the bad-functioning interbank market, and a wider range of assets has been accepted as collateral by central banks.

State guaranties for new bank loans has been introduced in many countries, and authorities have bought private sector bonds.

An increasing number of countries have introduced arrangements for up-capitalizing the banks by supplying core capital in some form or another. Banks have to increase core capital adequacy to be better equipped for future losses and to get finance in international markets. In order to keep the wheels in the economy going, it is in addition crucial that banks continue to supply credit to households and businesses.

The alternatives for banks to increase their core capital are either to abolish dividend pay, to curb lending or to raise capital in the market. The latter is difficult in the current market situation. If banks curb lending growth, this will fortify the downturn in economic activity. Government actions will aim at preventing this.

Given the magnitude of the economic downturn more and more countries have in addition carried out fiscal policy stimulus.

And as final group of measures, a lot attention is given to improve the regulations of banks and financial markets. The aim of the work in this area is to make financial markets more stable, and to prevent something what we now are experiencing to happen again.

 

Comprehensive measures also in Norway
So far avoiding the most dramatical consequences Norway is in position to address upcoming challenges. In my opinion we are doing what’s need to be done. And we have under the last six months taken of measures.

Monetary policy:
Norges Bank has reduced interest rates in four rounds, and taken interest rates down point to 2½ per cent.

The decline in the risk mark-up in money markets after the Government Swap Facility was presented in October, has together with lower interest rates from Norges Bank, resulted in a significant decline in money market rates.

Bank lending rates have also been clearly reduced, and Norges Bank’s interest rate reductions  will increase household income by 25 bill. NOK if full pass-through to lending rates.

Fiscal policy:
Budget policy is now more expansionary than ever before in any single year over the last 30 years. The overall domestic demand stimulus is estimated at 2.4 per cent of Mainland GDP. The expansionary impulse is stronger than in most other countries, even those that are much more heavily affected by the financial crises than Norway. It is only UK and US that seems to be on par with the Norwegian fiscal policy stimulus.

Fiscal policy and monetary policy taken together now gives substantial stimulus to the economy, and dampen the effect of the financial crises.

The October 12th measures
The Government and Norges Bank introduced two targeted initiatives to enhance confidence in the financial market last october. Through the issuance of government bonds amounting to 350 billion kroner the Government provides collateral that may be used in banks’ funding operations. Norges Bank provides liquidity loans of two year maturity (later on prolonged to 3 years) especially targeted at smaller banks.

The funding situation for the banking sector deteriorated significantly in September and October.

The swap facility makes it easier for banks operating in Norway to fund themselves.

The bonds are made available to the banks for periods of up to five years against collateral. Banks may surrender covered bonds, including bonds issued by a mortgage association within the bank group. The facility is made available against a market based premium (however, there is a floor price on the premium). So far the agreed amount of swaps has been 72 bill. NOK.

These measures have had a positive effect on liquidity and borrowing for Norwegian banks. We do however now face new challenges, which require other types of measures. Turning from a liquidity problem, to a solvency challenge.

The February 8th measures
To ease access for funding of business and households the Government February 8th proposed two new credit measures, the State Finance Fund and the State Bond Fund.
Each fund with a capital of 50 billion NOK.

Both these transactions will be covered by borrowing in the market and/or drawing on the Treasury’s cash reserves.

 

The State Finance Fund
The State Finance Fund will be established as a separate legal entity, with NOK 50 billion in capital.
The funds aim is to that all Norwegian banks fulfilling prudential requirements may have access to core capital at reasonable market terms.
The fund could increase core capital adequacy in banks by 3-3½ p.p. on average.
A core capital of NOK 50 billion may in itself correspond to a lending capacity of NOK 400-500 billion NOK.

At present, Norwegian banks are financially sound, but they need to strengthen their core capital in order to counter a weaker economy and enhance their competitiveness.

The purpose is to temporarily provide core capital to enable the banks to maintain normal lending in a period with difficulties in the financial markets.

Banks meeting ordinary prudential requirements may apply for injection of capital from the Fund. Specific terms and conditions are to be determined in agreements between the Fund and the individual banks applying for capital. The Ministry of Finance will determine general terms for the instruments the Fund may use.

Conditions will be set to make sure that the supply of capital is used to increase lending, and not to increase dividends, salaries or bonuses.

The purpose for this Fund will be to provide tier 1 capital to financially sound Norwegian banks in order to strengthen the banks’ core capital and to improve their lending capacity.

We have set up two different types of instruments. One instrument will be similar to, “fondsobligasjoner”, which is a capital instrument presently issued by banks that may be recognised as core capital. The preferance capital instrument will be designed with a risk profile close to shares/grunnfondsbevis (primary capital certificate). Both instruments will be designed with a coupon, reflecting risk. The coupon will be non-cumulative, and subject to annual profit.

Central elements determining yield and risk for the Government will be the instruments’ priority with respect to loss absorption, redemption terms, and eventual convertibility and other loss-sharing provisions.

The State Finance Fund measure will be designed to meet state aid requirements in the EEA agreement, the ESA guidelines for permissible state aid, and the ECBs recommendations with respect to price structure.

 

The State Bond Fund
The objective of the State Bond Fund is to contribute to improved capital market liquidity by investing in a diversified manner at fair market prices in fixed income instruments issued by Norwegian companies. The fund would be built up the next year or so, for then to be gradually reduced and wound up in due course. Operational management would be undertaken by Folketrygdfondet, which is a professional asset management organization owned by the state.

The investments of the bond fund would be similar to Folketrygdfondet’s current management of the bond portfolio of the Government Pension Fund – Norway. The bond fund would have a similar governance framework, where the Ministry acts as the owner and where Folketrygdfondet makes independent investment decisions according to a clear mandate and with appropriate reporting requirements.

It is important that the fund is large enough to achieve its objective, but not so large that they completely dominate the corporate bond market.

The fund will invest both in the primary and secondary market. Considering the structure of the market and operational risk considerations, investments would be dominated by bonds with low to moderate credit risk.
 
A crucial question may be: “What kinds of bonds will the Fund by?” The short answer is that they will by the market. The Fund will not be directed against any special segment or sector. The total market is 750 bill. NOK, and then loans taken up abroad is excluded. The size of dues in 2009 is 170 bill. NOK.

 

Summing up
The financial crisis seems to have lead to a profound global recession. Internationally, comprehensive measures have been introduced to improve money and credit markets and reduce the effects of the finance crisis on market economy. Still growth prospects are very weak.

Handling the financial crisis is like bringing up an unexpected child. In the first months the screaming all day and night, freaked the whole world out. Today we have a half year old toddler still making quite a turmoil, and worrying the parents, eagerly trying to manage the upbringing and drawing new boarders everyday. Ass all parents we are worried about the future for the child, and especially worried that he will ruin us. The hope still remain: most problem-child’s, grow up to bee good citizens. So we will just have to hang out the trouble full early years, and hope that the crisis will grow up, to be a stronger and more healthy international economy.

Thank you!