Norway’s Financial System

INTRODUCTION Purpose of this paper is to discuss the characteristics of Norwegian financial system, including the regulatory environment in which it operates and in particular, the relationship between the financial and corporate sectors of the economy. In order to do this, the first part analyses Norwegian banking system while the second part looks at the financial markets. BANKING SYSTEM Efficiency According to Author (2004), the stable outlook for the Norwegian banking system is based on the banks’ strong domestic franchises, sound financial fundamentals and overall low risk profile. The system can also be described by intense competition and a decline in interest rates. Although the Norwegian banks’ asset quality indicators deteriorated in 2002-2003, ratios have improved since.

The Norwegian strong economic expansion since the summer of 2003 has resulted in Norwegian banking sector’s best performance since 2000 (Kredittilsynet 2006). The favorable macro-economic developments have translated into improved bank earnings in 2003 and 2004, driven especially by a reduction in loan losses to very low levels (IMF 2005). The banking system is highly automated and computerised (US Commercial Service 2007). Bank results have been solid in 2006 (Norges Bank 2006). Although banks’ total pre-tax profits as a share of average total assets declined compared to 2005, return on equity in the largest Norwegian banks is solid compared with their Nordic financial conglomerates. Bank Categories According to the US Commercial Service (2007), the Norwegian banking system is comprised of commercial banks, savings banks and a small number of state-owned banks that provide financing for particular purposes. Other principal financial institutions are mortgage companies, finance companies and insurance companies. Foreign banks have been allowed to establish subsidiaries in Norway since 1985, and since the implementation of the EEA Agreement in January 1994, foreign banks may also establish branches in Norway. Commercial banks enjoy a very close relationship with trade and industry. Savings banks have a long tradition in Norway and cover a substantial part of the local credit requirements.

Merchant banks have not achieved the same position in Norway that they enjoy in some countries partly because of the market dominance by the very large commercial banks. There are special banks for fisheries, agriculture, shipping, industry, house building, and export finance.

The state participates in all of these. Foreign exchange controls were abolished in 1990. No licensing requirements are in force. The only requirement is a reporting requirement for international payments and financial transactions. The transaction bank generally takes care of this reporting.

Savings banks, and foreign subsidiaries and branches, are often organised as parts of wider groups that also include mortgage companies, finance companies, securities funds and life and nonlife insurance companies (IMF 2005). Furthermore, though less so than in some neighboring countries, Norway’s banking system is relatively concentrated, and in particular the largest domestic financial conglomerate, DNB-NOR continues to hold a very substantial market share. Its importance is further increased through its role as the settlement bank for many smaller banks in the system. Number of Banks in Norway The Norwegian banking system is comprised of 15 commercial banks, 129 savings banks and a small number of state-owned banks that provide financing for particular purposes (US Commercial Service 2007). According to IMF (2005), as of June 2004 there were 149 banks with 884 branches in Norway and abroad, and 2 foreign banks with 8 branches in Norway. The largest bank is DnB NOR Bank, followed by Nordea Bank Norge, Fokus Bank and Handelsbanken (Norwegian Financial Services Association 2006a). Deposits and Lending Total amount of net loans to customers in 2005 was 2,346 billion NOK (USD383 billion), with DnB NOR providing 692 billion (USD 113 billion) on its won (Norwegian Financial Services Association 2006b). Total number of deposits from customers in 2005 was 1,192 billion NOK (USD 195 billion), with DnB NOR leading the way with 418 billion (USD 68 billion) (Norwegian Financial Services Association 2006b). Hybrid Capital Instrument Several banks have raised capital in recent years by issuing hybrid capital instruments (Kredittilsynet 2006). Hybrid capital instruments share clear similarities with both debt and equity capital instruments. They enjoy better priority than share capital but poorer priority than subordinated loan capital. The number of banks having issued hybrid capital instruments rose from 29 in 2004 to 47 in 2005. Central Bank The Bank of Norway (Central Bank) is organised as a share-issuing company, but the government owns all the shares. It is the executive and advisory entity for monetary, credit and exchange policy.

The bank is responsible for authorising interbank systems in Norway(US Commercial Service 2007). The Main Sources of Finance for Industry Banks are, by far, the main source of finance for industries. According to Statistics Norway (2006), banks provide 557 billion NOK (USD 91 billion), out of total 783 billion (USD 128 billion). “Other credit institutions” provided for 170 billion(USD 28 billion) , while state lending institutions provide 53 billion (USD 9billion). Ownership In June 2004, no bank was owned by the government (IMF 2005). The government had the last ownership of a bank in year 2000. However, there were three state lending institutions in 2005 (Statistics Norway 2006). Corporate Lending and Mortgages Market Norwegian banks reported substantial growth in lending in 2005, close to 17 per cent (Kredittilsynet 2006). Lending growth has been on the rise since the third quarter of 2003. Growth in lending to wage earners has been high for several years, and rose by almost 15 per cent in the past year (adjusted for portfolio transfers). Increased fixed investment has brought quickening growth in loans (almost 17 per cent in 2005) to Norwegian corporate customers. Growth in lending to foreign corporate customers rose by 64 per cent in the same period, mainly through the largest Norwegian banks’ foreign branches. Foreign branches in Norway posted far higher growth than Norwegian banks, at 34 per cent in December 2005. Lending in 2005 to industries was 557billion NOK (USD 91 billion). The larges market was “real estate and business activities” with 284 million (USD 46 billion), “real estate” with 221 billion (USD 36 billion) and “wholesale and retail trade, operation of hotels and restaurants” with 59 (USD 10 billion) (Statistics Norway 2006). All kinds of financing are available to foreign investors (US Commercial Service 2007). Overdrafts and mortgages are available from banks, which will also assist in the issuance of such financial instruments as discount bonds, convertible bonds, etc.

Financial lease arrangements are supplied by leasing companies. Venture capital and merchant banking are not highly developed, but do exist. Eksportfinans ASA finances exports of Norwegian capital goods and services on both market and government supported terms. The financing programs are designed to promote the sale of Norwegian capital goods and services, and financing is also available to foreign buyers. Where exports are involved, the Government of Norway is able to offer subsidized fixed-rate loans to most countries.

Government-supported loans are regulated under the OECD consensus agreement. Norway offers no significant financing programs for either domestic or foreign investors.

One exception is investments in northern Norway. Competition for home loan customers is intense ((Kredittilsynet 2006). Norwegian banks’ margin on lending to households is below the level for Swedish and Danish banks. This is partly because loans for housing purposes in Sweden and Denmark are provided by mortgage companies as fixed-interest loans. In Norway loans for housing purposes account for more than 60 per cent of total loans from banks and more than 90 per cent of them carry a floating interest rate. There is also a strong growth in lending to the commercial property sector (Norges Bank 2006). Supervision According to the US Commercial Service (2007), the Financial Supervisory Authority of Norway (Kredittilsynet) supervises all banks and other financial institutions in Norway.

The Commercial Banking Act, the Savings Bank Act and the Act on Financing and Finance Institutions regulate banking activities. Norway has revised the regulations relating to financial institutions as a result of the EEA Agreement. With respect to financial services, the EEA Agreement provides for full adaptation to EU regulations. The Central Bank of Norway is responsible for authorising interbank systems in Norway. FINANCIAL MARKETS Deregulation of financial markets, liberalisation of capital markets, along with technological and demographic changes, have altered financial institutions’ operating environment (Kredittilsynet 2006). Five sizeable financial groups: DnB NOR, Nordea Bank Norway, Fokus Bank, Handelsbanken and Sparebanken Rogaland, account for a substantial share of the Norwegian financial market. The three largest life insurance companies: Vital, KLP and Storebrand, hold a combined market share of 87 per cent.

The four major players in the Norwegian non-life insurance market: Gjensidige Forsikring, If, Vesta and Sparebank skadeforsikring, hold a combined market share of 75 per cent measured by gross premium revenues. Foreign ownership shares in the Norwegian market are especially large among finance companies (Kredittilsynet 2006). Branches and subsidiaries accounted for a total market share of 65 per cent measured by total assets. There are 33 foreign-owned finance companies operating in the Norwegian market, half of them foreign branches. In the non-life insurance field, the foreign share is 42 per cent. If and Vesta Forsikring are the largest foreign-owned companies. Foreign actors have shown keen interest in the banking market in recent years.

Foreign-owned subsidiaries’ market share is primarily accounted for by Nordea Bank Norway and Fokus Bank. In addition, several of the foreign branches, of which Handelsbanken is the largest, reported very high lending growth in the Norwegian market in 2005. Oslo Børs Stock Exchange According to Oslo Bors (2007), there are four main product areas: shares and primary capital certificates, bonds and other fixed income instruments, derivatives and warrants. The market capitalisation of Norwegian companies listed on Oslo Børs came to about one-third of Norway’s GDP at the end of 2005 (Kredittilsynet 2006). Shares listed on the Oslo Stock Exchange (OSEBX) rose by fully 40.5 per cent in 2005, while turnover of listed shares increased by 67 per cent and amounted to a total of NOK 1500 billion (USD 245 billion). The rate of turnover has been increasing for many years, and in 2005 that of the Oslo Stock Exchange is es­timated to be close to 130 per cent. Large government ownership interest is more prominent in the case of Norway than other countries. Government increased its ownership from 23 to 34 per cent from 2000 to 2005. Large number of new companies have been listed on the Oslo Stock Exchange (Norwegian Financial Services Association 2006c). At the end of 2005, 31 more companies were listed than at the beginning of the year, despite the fact that 15 companies had been delisted. There were a total of 245 companies listed on September 2006. EQUITIES According to Oslo Bors (2007), market value in 2006 was 1915 billion NOK (USD 313 billion), which was 512 billion (USD 84 billion) increase from 2005. Norwegian companies accounted for 1748 billion (USD 285) and foreign companies for 167 billion (USD 27). Foreign companies experienced a significant increase by 50% in respect to 2005. Leader in market share in 2006 was DnB NOR with 468 billion NOK (USD 76 billion). BONDS According to Oslo Bors (2007), there were 744 issues in 2006, down by 87 since 2005 and the lowest in the last 10 years.

Banks and insurance group accounted for 267 and industries for 178. Number of issuers was also down from 201 in 2005 to 186 in 2006, lowest in the last 10 years. Industry accounted for 70 and the local government for 43. Number of transaction declined from 32589 in 2005 to 28799 in 2006. Government accounted for the largest number with 15508, followed by 4457 from banks and insurance companies.

Market value has increased from 538 billion NOK (USD 88 billion) in 2005 to 548 billion (USD 89) in 2006, with government accounting for 193 billion NOK (USD 32 billion) and bank and insurance 129 billion NOK (USD 21 billion). There was a significant increase for foreign companies from 4 billion NOK (USD 653 million) in 2005 to 9.4 billion (USD 1.5 billion) in 2006. Turnover increased from 646 billion NOK (USD 105 billion) in 2005 to 690 billion (USD 113 billion) in 2006. DERIVATIVES Turnover has increased from 5351 billion NOK (USD 874 billion) in 2004 and 3823 billion NOK (USD 624 billion) in 2005 to 6200 billion NOK (USD 1012 billion) in 2005 (Oslo Bors 2007). Overall there were 43 per cent more transactions in the derivatives market in 2005 than the previous year (Norwegian Financial Services Association 2006c). Securities Market Although financial institutions will retain their dominant role in many countries as savings and financing intermediaries, the importance of securities markets is likely to increase ahead. Trading on the securities market showed especially strong growth in 2005 Norwegian Financial Services Association (2006c). Money Market Although small, money and forex markets appear to be relatively well functioning and adequately liquid in normal times (IMF 2005). There have been no instances of significant disturbances in recent years. Foreign exchange settlement risks have significantly been reduced since 2003 through Norway joining the Continuous Linked Settlement (CLS) system. About 10-11 market players quote firm FX prices, although it is not a formalized primary dealer system.

The short-term interbank money market is less active, with price quotations generally indicative rather than firm, and a few large players dominating the market. But there have been no signs of monopolistic behavior and market participants have been able to distribute liquidity amongst themselves with limited recourse to NB’s facilities. Trading in both FX-related and interest rate derivatives is active, and surveys indicate the markets are liquid. Life Insurance and Pensions Market Positive trends both in Norwegian and in international equity markets have led to increased returns for the life insurance companies (Norwegian Financial Services Association 2006c). Premium incomes increased further during 2005. The new Act relating to mandatory occupational pensions opens new markets for the sale of pensions (Norwegian Financial Services Association 2006c). The life companies have increased their proportion of in­vestments in shares during 2005. Increased returns on the shares portfolio are the reason for the companies’ improved value-adjusted return on capital. For 2005 value-adjusted return on capital was on average 8.1 per cent, against 7.0 per cent in 2004. At the same time the life companies had on average capital adequacy of 12 per cent in 2005 and all companies satisfied the capital adequacy requirement of 8 per cent. New Regulations Developments in the EU have resulted in substantial chan­ges in the Norwegian legislation relating to securities (Norwegian Financial Services Association 2006c). A Committee on Markets in Financial Instruments was appointed, which has proposed a new Securities Trading Act that might be in place on 31 October 2007. New sup­plementary rules are also being developed for the conduct of business in the market and in relation to customers. Ex­tensive reporting systems with availability throughout the EEA must also be in place by the aforementioned dead­lines. In 2005, new rules relating to insider trading and mar­ket manipulation were adopted, and the Commit­tee proposed new rules for public tenders. New rules have also been propo­sed for improving the efficiency of government sanctions associated with contraventions relating to securities.

The new legislation, together with the very extensive and detailed rules for good business practice and conduct, implies a change of regime for the Norwegian securities market. The new rules are far more detailed than previ­ously, and the authorities will have more effective sanc­tions for penalising contraventions. New Financial Instruments In parallel with this, new financial instruments are ente­ring the Norwegian securities market and investment fund legislation, as Norwegian suppliers will be able in due co­urse to supply instruments that have previously only been sold by foreign suppliers (Norwegian Financial Services Association 2006c). This applies in particular to specialised funds, primarily hedge funds and private equity, where legal amendments are being prepared pursuant to a draft that was circulated for comment in 2005. Separate rules and regulations for banks’ use of credit derivatives to reduce individual risks and requi­rements relating to capital adequacy for credit risk have been circulated for comment. CONCLUSION The paper has analysed the characteristics of Norwegian financial system, focusing on Norwegian banking system and financial markets. Largely centralised banking environment has been solid in 2006 , with largely increasing deposits and lending. Banks are the main source of finance for industries, accounting for over 70%, and are entirely privately-owned.

Small number of financial institutions accounts for a large portion of the financial market. Oslo Bors is the major stock exchange, with an increasing equity and derivatives market and fluctuating bonds market. Securities market is likely to increase further, with small money marketing functioning well. Life insurance and pensions markets are also increasing. New regulations and the new financial instrument are soon to further strengthen Norwegian financial system. BIBLIOGRAPHY Author (2004). “Norway: Stable Rating Outlook for Banking System”. www.findarticles.com/p/articles/mi_go1493/is_200408/ai_n6286942 IMF (2005). “Norway: Financial System Stability Assessment, Including Reports on the Observance of Standards and Codes on the Following Topics: Banking Supervision, Insurance Regulation, and Payment Systems”. IMF Country Report No. 05/200 Kredittilsynet (2006). “The Financial Market in Norway 2005: Risk Outlook”. Norges Bank (2006). “Financial Stability 2/2006”. www.norges-bank.no/front/rapport/en/fs/2006-02/ Norwegian Financial Services Association (2006a). “Ten Biggest Banks in Norway”. www.fnh.no/fullstory.aspx?m=1689 Norwegian Financial Services Association (2006b). “Market Share – lending to and deposits from customers”. www.fnh.no/fullstory.aspx?m=1689 Norwegian Financial Services Association (2006c). “Financial Year 2006”. Oslo Born (2007) www.oslobors.no. US Commercial Service (2007). “Norway: Trade and Project Financing”. https://www.buyusa.gov/norway/en/financing.html

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