However, one can argue that there is something wrong in the level of profits shown if the latent credit risk in the loan portfolio is not properly taken into account. Intrinsically every loan has an expected (or potential) loss that should be recognised as a cost by means of an early provision. Otherwise, the picture of the true profitability and solvency of the bank over time could be distorted. More dangerously, the overvaluation of profits might lead to an increase in dividends that could undermine the solvency of the bank. Therefore, the acknowledgement of latent losses is a prudent valuation principle (similar to the mathematical reserves set aside by insurance companies) that contributes to correcting the cyclical bias that currently exists in the profit and loss account. The management of credit risk in the banking sector has perhaps something to learn from insurance practices. Theoretical papers on bank credit risk management also go in the same direction, stressing the importance of proper pricing (i.e. the interest rate charged should cover expected losses as well as the cost of holding capital for unexpected losses). Estimating expected losses when the bank assesses the borrower is the first step for sound risk management. Proper risk management is obviously a primary task of bank managers and shareholders. But we, as bank supervisors, should evaluate the effectiveness of a bank’s policies and practices for assessment of loan quality and provisioning practices.
Economic perspectives Address by Governor Øystein Olsen to the Supervisory Council of Norges Bank and invited guests on Thursday 15 February 2018  Analyses and charts are based on information up to and including 9 February 2018  Thursday 15 february 2018  Economic perspectives 2017  Norges Bank Economic perspectives 15 february 2018  Introduction “All things will pass, even a crisis. After the darkness comes the dawn.”1 With these words, former central bank governor Nicolai Rygg summarised the turning point in the 1930s. The advanced economies have emerged from another challenging period. Ten years ago the world economy was hit by a shock and thrown into the deepest recession since the 1930s (Chart 1). Chart 1 Economic growth following the financial crisis. GDP per capita. Index. Value in year recession started = 100 120  120  Euro area (2007=100) US (2007=100) Previous recessions 1)  110  110  100  100  90  90  80  80 −5 −4 −3 −2 −1  0  1  2  3  4  5  6  7  8  9  10  Number of years before and after recession 1) The first year of a recession is defined as a year where per capita GDP growth turns negative. Previous recessions are defined as the median of all recessions in the period 1920 – 2002, based on the Jordà−Schularick−Taylor Macrohistory Database. The database covers 17 countries.