One reason for these developments is that net price gains on securities have increased in this period. Bearing in mind that this was a favourable period for securities markets, it will be difficult to maintain the income share from price gains in periods of more normal returns in securities markets. With a slower rise in house and commercial property prices and lower lending growth, combined with a normalisation of loan losses, banks may find it more difficult to maintain the high level of profitability that we have witnessed in recent years. The new capital adequacy rules have had a strong impact on Norwegian banks and will continue to do so in the years ahead. How banks choose to utilise capital freed up as a result of the reduced minimum capital requirements, may have an impact on both competition and structure in the Norwegian banking sector. Freed-up capital may be used to finance lending growth, acquire other institutions or pay back capital to shareholders and other stakeholders. On average, Norwegian banks’ capital adequacy is solid. However, the substantial reduction in minimum capital requirements, even though there are transitional arrangements, also entails some risk that banks will reduce their capital to such an extent that the buffer needed to meet unforeseen events may become smaller than advisable. Banks’ profitability may also depend on the duration and severity of liquidity problems in international financial markets. Although Norwegian banks are probably somewhat less exposed than banks in many other countries, the impact may nonetheless be felt.
Norwegian covered bonds are very different from US CDOs backed by subprime mortgages. The regulations ensure that Norwegian covered bonds are a more transparent and substantially more secure investment alternative. The cover pool in the mortgage credit institutions consists of mortgages with a maximum loan to value ratio of 75 per cent. The loan to value ratio of the cover pool in Norwegian mortgage credit institutions that have so far issued covered bonds is well below this. All holders of covered bonds have the same right to the mortgage credit institution’s cover pool. In other words, there is no tranching as is the case for CDOs backed subprime mortgages. Investors will also have an overview of the risk parameters for mortgages that are part of the cover pool. This means that Norwegian covered bonds are far more transparent with respect to the assets that are the bondholders’ cover than CDOs backed by US subprime mortgages. Another difference between subprime mortgages in the US and Norwegian mortgages is that the regulations relating to the provision of credit are stricter in Norway. Subprime mortgages in the US have been sold through agents and mortgage brokers that have not been subject to federal supervision. In a number of cases, mortgages have been extended to persons with no income. Before Norwegian banks extend a loan, they assess a customer’s debt-servicing capacity. Norwegian banks are also required to advise a customer against taking out a mortgage if they feel that the customer will find it difficult to service the loan.