Changes in banks’ capital requirements from year-end 2020

“Banks will have more time to adapt to the new systemic risk buffer requirement, and the changes should not lead to an increase in banks’ overall capital requirements. We have had a constructive dialogue with the banks, and I have accommodated them on important points,” says Minister of Finance Siv Jensen.

The amendments will be formally adopted in early 2020, following notification procedures vis-à-vis relevant EU/EEA authorities. Today, the Ministry has also sent a letter to the Financial Supervisory Authority on the relationship between general buffer requirements and the Pillar 2 process.

Background

The Ministry of Finance conducted a public consultation on draft amendments to banks’ capital requirements from 25 June to 30 September. The purpose of the draft was to maintain banks’ actual requirements at a level that is commensurate with prevailing risk factors in the Norwegian economy, and also contribute to more equal requirements for Norwegian and foreign banks’ activities in Norway. If no amendments are made, the capital requirements for many Norwegian banks will be reduced in real terms when the EU capital requirements framework (CRR/CRD IV) enters into force as part of the EEA Agreement on 31 December 2019. The framework introduces the so-called SME discount factor, which will lower banks’ capital requirements for lending to small and medium-sized enterprises. Moreover, the Basel I floor will be abolished. The floor has prevented unjustifiably low capital requirements for banks using the internal ratings based approach (IRB banks). In total, the entry into force of the framework implies that banks’ capital adequacy ratios will be calculated in a different way than before.

Changes in the requirements from year-end 2020

The Ministry intends to increase the systemic risk buffer requirement from 3 to 4.5 per cent, effective from 31 December 2020, which is one year later than proposed in the consultation paper. Since this buffer requirement targets structural vulnerabilities and other systemic risks in the Norwegian economy, it should only apply to banks’ exposures in Norway, in contrast to the current systemic risk buffer requirement, which applies to all exposures. Any buffer requirements that target systemic risk in other states should also apply to Norwegian banks’ activities in those states. The Ministry has clarified this further in a revised draft regulation. The grounds for setting the Norwegian systemic risk buffer requirement at 4.5 per cent is further discussed in a new memo from the Ministry.

The overall capital requirements shall be commensurate with the risks that banks are exposed to. The capital requirements consist of general Pillar 1 requirements set by the Ministry of Finance, and bank-specific Pillar 2 requirements set regularly by the Financial Supervisory Authority to cover risks that are not covered by the general requirements. The increase in the systemic risk buffer requirement does not reflect changes in the overall risk outlook for banks, but rather a restructuring of the use of regulatory tools, where more risk is covered by the Pillar 1 requirements. The restructuring should be accompanied by a review of the division of labour between the various elements of banks’ overall capital requirements.

“There are no changes in the risk outlook that indicate that banks’ overall requirements should increase, and it is important that changes in the general buffer requirements are taken into account in the Pillar 2 process when there are grounds for doing so. The Ministry has therefore today sent a letter to the Financial Supervisory Authority on the relationship between general buffer requirements and the Pillar 2 process,” says the Minister of Finance.

The smaller banks using the Standardised Approach or the Foundation IRB Approach, receive no significant reductions in their capital requirements as a result of the Basel I floor being abolished. The Ministry will therefore adopt a transitional rule for these banks, after which they will be subject to the current systemic risk buffer requirement at 3 per cent for all exposures until 31 December 2022.

More equal requirements for Norwegian and foreign banks in Norway

The Norwegian systemic risk buffer requirement should also apply for foreign banks in Norway, which have a total market share of about 25 per cent. In accordance with the CRR/CRD IV framework, the Ministry will shortly submit a notification on the new systemic risk buffer requirement to EU and EEA authorities concerned, and at the same time request the European Systemic Risk Board (ESRB) to issue a recommendation to other EEA states to reciprocate the requirement. If the requirement is reciprocated and made applicable for foreign banks, this will promote stability and fair competition in the Norwegian banking market. The new systemic risk buffer requirement will formally be adopted after the notification procedures vis-à-vis EU and EEA authorities have been completed, which is expected to take about one month.

In order to ensure that Norwegian residential and commercial real estate exposures are not assigned unjustifiably low risk weights by IRB banks, the Ministry intends to adopt temporary floors for average risk weights for such exposures at 20 and 35 per cent, respectively. The floors will be applicable for a period of two years from year-end 2020. As discussed in the consultation paper, the average risk weights in most Norwegian banks are around or above these levels today. The floors may however promote a more prudent treatment of real estate exposures in the small number of foreign banks that operate with lower average risk weights. The measure must be notified before it can be formally adopted, and the Ministry will request the ESRB to issue a recommendation to other EEA states to reciprocate the measure.

The Ministry will publish the notifications on the systemic risk buffer requirement and the risk weight floors when they are submitted to the EU and EEA authorities concerned. The Ministry’s new memo on the systemic risk buffer requirement will be an appendix to the notifications.

Changes in the rules on systemically important banks

The Ministry intends to adopt amendments to the rules on the separate buffer requirement for systemically important banks, so that the buffer requirement will be differentiated based on the degree of systemic importance. Banks that meet the current criteria should be subject to such a buffer requirement of 1 per cent, while the buffer requirement should be 2 per cent for banks that score at least twice as high on the same objective criteria. Moreover, the buffer requirement shall be regarded as an O-SII (other systemically important institutions) buffer requirement pursuant to the CRR/CRD IV framework, and therefore apply to all exposures. The O-SII buffer requirement will apply cumulatively with all other buffers. Together with the changes in the systemic risk buffer requirement, the differentiation of the O-SII buffer implies that the overall capital requirements for the two banks currently identified as systemically important in Norway (DNB and Kommunalbanken), will be maintained at approximately the current level in real terms.

More:

• Memo of 11 December 2019 from the Ministry of Finance on the systemic risk buffer requirement (PDF)
• Revised draft regulation (in Norwegian only) (PDF)
• Press release of 25 June 2019 from the Ministry of Finance on the public consultation