Norway’s central bank has proposed higher haircuts on collateral submitted for repo to reflect heightened volatility in securities markets. The changes should have a small market effect, said one analyst, while a Norges Bank spokesperson explained changes to covered bond treatment to The Covered Bond Report.

Norges Bank said in the consultation released on Friday that it had previously flagged its intention to raise haircuts.

“The experience of the financial crisis and ongoing turbulence in financial markets have shown that current haircut rates are too low,” it said. “When Norges Bank amended the guidelines in 2010, consultative bodies were notified that haircut rates would be raised.”

The changes are due to apply as of 15 February 2012, with the Norwegian Financial Services Association and Finanstilsynet, the Norwegian financial supervisory authority, asked to comment on the consultation by 2 December.

Changes proposed, on top of a general increase in haircuts, include: a 15% haircut on asset backed securities regardless of maturity; an additional haircut on foreign currency denominated securities of five percentage points instead of three; and an additional haircut of five percentage points for bonds issued by mortgage companies belonging to the same corporate group as the borrower or that are considered related to the borrower under the Norwegian Accounting Act.

Floating rate securities will be subject to haircuts according to maturity, rather than according to the time remaining until the next rate adjustment, regardless of maturity.

Norges Bank said that the proposed haircut rates entail an increase in the value-weighted haircut from 4% to 9%, with changes in haircuts for ABS and covered bonds and a higher foreign currency haircut the primary contributors to the increase.

A Norges Bank spokesperson said that it was not straightforward to compare the proposed haircuts on covered bonds with those under the existing framework because the categories had also changed, and that this was why the central bank had only provided a figure for the increased haircuts on a value-weighted basis.

The second category under the prevailing framework had been divided into categories two and three under the new framework, he said, while the “best” covered bonds under the existing categorisation had been assigned to the new category two and the “worst” to categories three and four.

“When you change haircuts you also need to refine the categories to reflect the credit risk better,” said the spokesperson.

Erica Blomgren, chief strategist, Norway, at SEB, said Norges Bank believes that banks are borrowing money too cheaply given prevailing market volatility and that the proposed changes, which are being consulted on, had not triggered any market reactions.

“This supports my view that the market effect should be rather small,” she said.

Jussi Harju, vice president, covered bond analyst at Barclays Capital, highlighted two aspects of the proposed changes that stem from the introduction of an additional 5% haircut on covered bonds issued by mortgage companies belong to the same corporate group as the borrower or considered as related.

“Norges Bank is introducing a differentiation between own covered bonds and covered bonds issued by an entity outside the borrowing group,” he says, “which is an approach that is not taken in other central bank collateral frameworks, such as by the euro system.”

In addition, the application of this additional 5% haircut means that a covered bond rated AAA (thereby falling into category two) would be subject to a harsher haircut than senior unsecured debt from a single-A rated issuer, said Harju. He acknowledged that issuers are not allowed to pledge their own senior unsecured debt as collateral, but said that it seemed odd for the credit risk of a higher rated covered bond to be treated as inferior to that of lower rated senior unsecured debt.

Category 2 collateral includes covered bonds with a credit rating of AAA to AA- but no senior unsecured debt, while collateral assigned to category 3 includes covered bonds with a credit rating of A+ to A, and senior unsecured debt from private Norwegian issuers rated triple-A to A, with these securities subject to the same haircut.

The Norges Bank consultation can be found here.

[Note of clarification: Norges Bank will no longer accept senior unsecured bank debt as of February 2012, but “bonds, notes and short term paper issued by private Norwegian issuers” rated triple-A to A sit alongside covered bonds with a credit rating of A+ to A in category three in the proposed framework. The categorisation under the prevailing framework refers to corporate issuers such as power companies or infrastructure companies and other Norwegian non-financial companies.]