In addition to increased competition between banks, new participants – both financial and non-financial – have contributed to increasing the pressure on margins. Securities markets have also become more important in terms of their role in saving, financing and risk management, adding to the pressure on financial intermediaries such as banks. Like banks in other countries, Norwegian banks have had problems compensating for the decline in net interest income by increasing other income or reducing costs. Intensified competition both between banks and from other financial market participants suggests that banks will in general be facing major challenges in the years to come. On top of this comes EMU, which will probably amplify some of these trends. The euro will have varying effects on different market segments. The most immediate consequence of the transition to the euro is the elimination of foreign exchange and hedging transactions in the BIS Review 16/1999  –5–  currencies concerned. As exchange between euro-country currencies accounts for a very limited share of total currency exchange in Norwegian banks, this will be of little consequence. Two other areas that will be directly affected are international payment transactions and liquidity management. International payment transactions do not represent a substantial source of income for Norwegian banks. However, it will be important for banks to be able to provide competitive payment services in euros to avoid losing customers. Foreign lenders today account for close to 30 per cent of all loans to Norwegian enterprises, a share that has been stable for the past five years.
For the time being inflation in Norway, although fairly moderate in absolute terms at just over 2 per cent, is considerably higher than inflation in the euro area. Narrowing this differential is a prerequisite for strengthening the krone and is thus the best contribution monetary policy can offer in the current situation. There are, however, obvious limits to how tight monetary policy can be. Interest rates cannot be set so high that it results in an unnecessary severe economic recession and deflation, because that in itself would reduce the credibility of monetary policy and most likely weaken the krone. Since August last year Norges Bank’s key rate has been 8 per cent – close to 5 percentage points higher than in the euro area. For the time being we find that our instruments are set in a manner consistent with bringing the krone back to its initial range over time. This illustrates the challenges of stabilising the exchange rate of a small, open, oil and commoditiesbased economy against that of larger, more diversified economies. Though a much larger economy, the UK has also over time experienced problems with exchange rate targets, most recently the events that led sterling to leave the ERM in 1992 and orient monetary policy towards an inflation target. The introduction of the euro from 1 January 1999 did not in itself require changes in Norwegian monetary policy. The euro could replace the ECU as the operational indicator of the external value of the krone.