Norway’s central bank has in feedback to its ministry of finance expressed support for considering limiting the use of covered bonds and opposed giving covered bond companies regular access to Norges Bank’s liquidity facilities, with comments from the FSA expected soon.

Norges Bank, Oslo

The country’s ministry of finance had in December written to Norges Bank and Finanstilsynet, the financial supervisory authority (FSA), asking the institutions for their views on the appropriateness of a soft – qualitative – limit on the amount of assets a parent bank can transfer to a covered bond issuer, and whether Norges Bank would grant specialised institutions restricted banking licences to grant them access to central bank liquidity. (See here for previous coverage.)

The ministry of finance’s move came after the FSA in October floated the possibility of it imposing higher capital charges on covered bond issuers or restricting issuance if it considers that too much collateral is being tied up in covered bonds. Regulatory attention in Norway is also focused on preventing an overheating of the residential mortgage lending market, with higher risk weights for residential mortgages under consideration, for example.

Norges Bank responded to the finance ministry’s request for feedback via a letter published on Thursday. The ministry had asked it to respond by 15 February, and the FSA by Friday. A spokesperson at the FSA told The Covered Bond Report that the FSA may publish a response later today (Monday) or tomorrow.

Based on a translation of the letter, which was published in Norwegian, Norges Bank said that it endorses the FSA’s and ministry of finance’s view that limits should be considered on the financing of residential and commercial mortgages via covered bonds (obligasjoner med fortrinsrett, or OMF) but that any limiting measures must take into account other regulations underway to reduce risk in the banking sector.

It highlighted benefits of covered bonds, such as diversification, lower financing costs, and their role as liquidity buffer constituents, and noted that there are “major” differences between banks in terms of the share of their loan portfolios used for covered bond issuance.

Challenges, however, include a weakening of senior unsecured creditors’ position in a crisis as a result of extensive pledging of assets, and risks posed to the Norwegian deposit guarantee fund.

Possible remedies, according to Norges Bank, include reducing implied guarantees of financial institutions, such as by introducing bail-ins as part of a new international crisis resolution system, and adjusting banks’ fees to the Norwegian deposit guarantee fund to better reflect the extent of pledged assets within an institution. Better disclosure would also be advantageous, it said.

Norges Bank then expressed its support for considering limiting the financing of commercial or residential mortgages via OMF.

The central bank had also been asked to set out its views on whether covered bond issuing mortgage companies should be able to borrow from Norges Bank on the basis of a restricted banking licence.

In Norway covered bond issuers are licenced as credit institutions, but not as banks, and the finance ministry has raised the question of whether they should be granted a restricted banking licence – allowing them to grant loans but not take deposits from the public.

In its comments on the subject of central bank borrowing Norges Bank refers to arguments put forward by Finance Norway, which is the secretariat to the Norwegian Covered Bond Council, for mortgage companies’ access to central bank liquidity facilities to reduce refinancing risk. However, it emphasised that the central bank’s liquidity facilities are designed to implement monetary policy and payment settlement, and not to limit liquidity risk or act as a funding source of a single entity, and that on these grounds OMF companies should not be given general loans from Norges Bank, and that a restricted banking licence “does not seem relevant in this context”.

Stein Sjølie, director at Finance Norway (FNO), said that Norges Bank’s stance on access to central bank liquidity for covered bond companies is not surprising given its general position on the role it should play in the Norwegian financial system.

“Compared with the ECB and other central banks Norges Bank takes a restrictive line,” he said. “It does not want to front the financial sector, to be the one providing extraordinary liquidity.

“The swap scheme set up in 2008 provided extraordinary liquidity and was managed by Norges Bank, but the ministry of finance was the formal counterparty.”

Sjølie also said that the FSA’s feedback to the ministry of finance is unlikely to contain any surprises.

In its letter to the finance ministry from Thursday the central bank noted that in certain circumstances – where financial stability is deemed to be at threat – it is entitled to provide extraordinary liquidity support to other financial institutions besides banks, i.e. including OMF issuing entities, but that it is “neither possible nor desirable” to predefine such situations.

This, too, is entirely consistent for Norges Bank, said FNO’s Sjølie.

“In the end it can be foreseen that Norges Bank and the ministry of finance would, as in 2008, provide extraordinary liquidity if needed,” he said, “but it is also predictable that Norges Bank refrains from giving any assurances.

“They want to keep their cards close to their chest and think that it is the responsibility of the financial institutions to operate in a prudent manner.”

Norges’s letter to the finance ministry can be found here.