With a minimum equity ratio of 5 per cent, for example, equity can be leveraged 20 times. Today, capital requirements for residential mortgage loans in particular are very low. The risk models employed by Nordic banks seem to apply risk weights for residential mortgage loans that are as low as between 7 and 15 per cent. Banks seeking to “put equity capital to work” are under very strong pressure to increase leverage. A risk weight of for example 10 per cent for residential mortgage loans with a minimum Tier 1 capital requirement of 4 per cent would mean that NOK 1 in equity capital could be behind as much as NOK 250 in residential  BIS Review 131/2009  5  mortgage loans. Introducing a leverage ratio requirement could have the effect of curbing banks’ debt financing and risk-taking. Banks in Canada are subject to both a strict national capital adequacy requirement and a maximum leverage ratio. Banks are required to maintain a minimum Tier 1 capital ratio of 7 per cent. The leverage ratio is defined individually for each bank. In principle, the leverage ratio should not be greater than 20. 6 Canadian banks have weathered the financial crisis well, also because of the less pronounced role played by market funding. 7  At the end of the 1800s, the equity ratio for banks in Norway was about 12 per cent. Over the years, this ratio has gradually decreased, falling to its lowest level during the banking crisis at the end of the 1980s.
Liquidity management More capital is important for the solidity of the banking sector. However, we must not forget that the turbulence first translated into a liquidity crisis, as was the case for the UK bank Northern Rock in autumn 2007 when depositors rushed to withdraw their savings. For Norwegian banks, the crisis has essentially been a liquidity crisis. Norwegian banks were affected because they became dependent on market funding. The financial crisis has revealed that substantial short-term money market funding is risky. When it comes from foreign markets, the risk of funding shortfalls increases. In the mid-1980s, Norwegian banks also borrowed heavily in foreign markets. In spring 1986 – following a sharp fall in oil prices – confidence in the Norwegian economy plummeted, and liquidity flowed out of the country as was the case in autumn last year. The funding source that is considered to be the most stable, deposits, has become less important over time. It is our assessment that the funding of Norwegian banks is a structural problem. When the financial crisis is behind us, we expect banks to give increased weight to deposits and long-term loans as funding sources. BIS Review 131/2009  13  The maturity of banks’ market funding should be longer than it was before the financial turbulence. During the financial crisis, investors were reluctant to provide long-term funding and required high risk premiums. Prospects for banks in general have now improved and risk premiums have declined. Strengthening of banks’ equity capital is helping to reduce the risk facing bondholders.