Svein Gjedrem: Housing finance in Norway
Speech by Mr Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), to the
Norwegian Covered Bond Forum, Oslo, 27 January 2010.
The text below may differ slightly from the actual presentation. This lecture does not contain assessments of the
economic situation or current interest rate setting.
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From state to private housing finance
After the Second World War, the credit market in Norway was regulated. Credit demand was
high. The Norwegian state endeavoured to steer credit flows towards priority sectors and the
state banks therefore played an important role as credit intermediaries.
There were considerable housing shortages after the war. For some population groups, living
conditions were poor. In1946, the Norwegian State Housing Bank was established to provide
credit for new residential construction. This bank and Statens Landbruksbank (the state
agricultural bank) dominated housing finance for new house purchases up to the 1980s.
State bank mortgage rates were initially set based on political objectives, but were over the
years gradually revised up and adjusted to market rates.
With the gradual deregulation of the credit market in the 1980s, state lending institutions
assumed a lesser role in housing finance and the private market took over. Sales of existing
homes increased. In 1992 private banks provided the majority of residential mortgages. Their
share of housing finance was also high compared with other Nordic countries. In Denmark
and Sweden, mortgage institutions were the primary source of residential mortgages. Even
though their importance has been reduced in recent years, mortgage companies still provide
most residential mortgages.
With the predominance of mortgage companies, fixed-rate mortgages have been a tradition
in Denmark and Sweden. This has not been the case for Norway. Mortgages from the State
Housing Bank were primarily adjustable-rate loans. After credit market liberalisation,
adjustable-rate mortgages were also offered by banks. The supply of fixed-rate mortgages
was limited. Fixed-rate loans are less common in Norway than in the other Nordic countries.
From the 1980s to the 1990s, the Norwegian economy moved from high to low inflation with,
until recently, falling nominal long-term interest rates. Borrowers with fixed-rate mortgages
fared poorly in this period, and even more poorly than maturity or mortgage insurance
premiums alone would imply. But with a clear monetary policy objective to keep inflation low
and stable - and with an independent central bank tasked with achieving this objective - the
result would be different. The high inflation expectations that were built into long-term interest
rates no longer exist and a further marked fall does not seem likely, nor for that matter does
any substantial inflation-driven increase in long-term rates. Purchasing a home is a long-term
investment. A fixed-rate mortgage reduces borrowers' uncertainty about expenses over the
life of the loan.
Longer-term financing in banks
Banks play an important role in the economy. Their task is to convert short-term deposits into
long-term loans. In times of crisis, fulfilment of this task is put to the test. A century ago,
depositors could lose confidence in the banks and rush to withdraw their savings. However,
deposits stabilised when guarantee schemes were established in the 1930s.
Loans to households make up a third of banks' assets. Residential mortgage loans are
longterm loans. At the same time, funding for Norwegian banks has changed. Market funding has
assumed a more important role. In recent years, both short-term market funding and funding
in foreign currency have grown in Norwegian banks. Banks have increasingly transformed
short-term deposits from international money markets into long-term domestic lending. This
is the main reason for the strain on liquidity experienced by Norwegian banks when foreign
funding came to a halt in 2008. For Norwegian banks, the financial crisis has primarily been a
liquidity crisis and not a solvency crisis.
The authorities all over the world are currently reviewing the regulation of banks' liquidity.
The Basel Committee on Banking Supervision presented recommendations on quantitative
liquidity requirements in December 2009. The UK, Switzerland and New Zealand have
introduced, or are in the process of introducing, stricter rules. Norwegian banks must also
expect the regulation of liquidity to be more stringent in the future. It will be more difficult to
base housing finance on short-term funding. Issuing covered bonds may be an alternative.
The collateral pool for covered bonds may comprise residential mortgages or mortgages for
holiday homes with a loan-to-value ratio (LTV) of up to 75 per cent, commercial property
mortgages with an LTV of up to 60 per cent or loans to public sector entities with an LTV
ratio of up to 100 per cent. These instruments are highly collateralised, carrying lower risk
premiums than ordinary bank bonds, and are well suited to pension fund investment and
other investments with a long-term horizon.
According to the rules for the issue of covered bonds, the value of the cover pool is required
at all times to exceed the value of the covered bonds. Both assets and liabilities are to be
recorded at estimated market value. This implies that a mortgage company must add further
collateral to the cover pool, for example in the form of government bonds, to replace any
shortfall.
An efficient bond market can handle large trading volumes without substantially affecting
prices. Such a market requires instruments that are easy to understand and clear regulation.
Trading should be transparent. Ideally, there should be multiple independent bidders and
askers and trading volumes should be high in primary and secondary markets.
Issues of covered bonds have picked up in Norway since the regulations relating to covered
bonds entered into force on 1 June 2007, supported since autumn 2009 by the arrangement
for the exchange of government bonds for covered bonds.
To facilitate banks' access to borrowing from Norges Bank during the period of financial
turbulence, collateral requirements for loans were temporarily eased. In October 2009, it was
announced that the temporary rules for collateral requirements would be changed.
Acceptance of new securities eligible under the temporary rules was discontinued in October.
Securities already approved under the temporary rules would be eligible as collateral until
maturity, or at the latest until 15 February 2012.
Changes in the so-called bank quota were also announced. Under the current rules, up to
35 per cent of a bank's borrowing facility can be based on collateral in bonds issued by other
Norwegian banks. Debt instruments issued by foreign banks will be included in the bank
quota as from 1 December 2010. Securities issued by banks will no longer be eligible as
collateral for loans as from 15 February 2012.
Covered bonds will still be eligible as collateral, including, until further notice, bonds to which
no credit rating has been assigned and bonds issued by a bank's own mortgage company.
This is expected to contribute to the development of the Norwegian covered bond market.
The housing market - a source of disturbances in the economy
Banks have had strong incentives to extend credit for house purchases. Even during the
banking crisis around 1990, Norwegian banks' losses on residential mortgages were low.
This is reflected in the low risk weights for residential mortgages in banks' risk models. For
an individual bank, residential mortgages are low-risk loans. However, market fluctuations,
accompanied by shifts in saving behaviour, are nonetheless a source of business cycle
fluctuations and substantial losses when banks have to write off loans to firms selling goods
and services to households.
With low risk weights for residential mortgages, banks can lend extensively, operating with a
substantially reduced equity ratio. As a result, banks are more vulnerable to disturbances in
funding markets. Thus, low risk weights for residential mortgages also lead to higher liquidity
risk in our banking system.
A high level of tax incentives for house ownership and a large volume of adjustable-rate
mortgages contribute to wide fluctuations in activity and prices in the Norwegian housing
market.1 The rise in house prices over the past two decades has also been very strong
compared with countries where housing bubbles have burst.
We have been through the longest period of uninterrupted house price inflation. In real terms,
house prices in Norway have tripled since the trough in 1992. House prices fell in 2007 and
2008, but have picked up again and have, in nominal terms, surpassed the summer 2007
peak.
Norwegian household debt is high compared with households in other countries. The number
of residential mortgages with a high loan-to-value ratio, i.e. above 80 per cent, has also
increased.
Periods of sharply rising house prices have historically been followed by periods of declining
prices. House prices can fall considerably over only a few years. Loan-to-value ratios will
then increase. Mortgage companies should therefore take housing market fluctuations into
account when issuing covered bonds.
Conclusion
I think it is fair to say that housing finance in Norway is in its infancy. There is a large
proportion of adjustable-rate loans. Fixed-rate loans offered in Norway are less
customerfriendly than, for example, in Denmark, where it is less expensive to cancel a fixed-rate
mortgage and where there is a secondary market, providing risk diversification. Mortgage
companies have a limited role in housing finance. Loan-to-value ratios are in some cases
alarmingly high. And last, but not least, banks finance their housing loans by means of
shortterm asset swaps in foreign markets. This is not a sustainable solution. I hope that this forum
can contribute towards the development of a better foundation for housing finance in Norway.
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