Thursday, 20 March 2014

Norwegian Money & Credit Review (as of Jan 2014) - A Surge in Base Money, Weak Norwegian Banks Balance Sheets

Base Money in Norway Surge Again

During the last couple of years, the monetary base (or base money) in Norway has remained fairly stable. This is in stark contrast to some other countries, particularly the U.S., the U.K and Japan, which have all expanded their monetary basis dramatically in the aftermath of the bank credit crisis which erupted in September 2008. Since peaking at NOK 167.428 billion in July 2009, the base dropped to a NOK 91.267 average during the February 2012 to November 2013. During the last couple of months however, the base has increased from NOK 93.274 billion in November 2013 to the most recent figure reported as of January 2014 of NOK 133.917 billion. This is the highest base reported since January 2012 when it hit NOK 134.738 billion.

Norwegian Monetary Base
Source: EcPoFi, Statistics Norway

The increase in the base during the last two months has resulted in the money base surging NOK 53.725 billion, or 67.0%, on the same month last year. This increase in the base was driven by Norges Bank (the central bank in Norway) expanding its holdings of Certificates and Bonds by NOK 43.159 billion during the same period.

Yes, Money Supply is increasing again, too – M1 and M2

The M1 money supply, the narrow monetary concept which includes notes and coins and transaction deposit accounts, was largely unchanged in January from December. It increased 6.5% compared to January 2013. Though an aggressive growth rate, it was 1.7 percentage point lower than the 8.2% average since 1996. The perhaps most interesting piece of information about the M1 was the pick-up in the year on year (YoY) growth rate during the last two months. Having averaged just 0.6% last year after declining for the first four months of last year, the YoY growth rate during the last two months has now been 6.0% and 6.5%. This is significant change and the fastest YoY expansion in the M1 since September and October 2011.

After averaging 6.8% in 2011, with a long term average of 7.2% since 1996, the YoY growth rate in the M2 money supply (a broader monetary concept than the M1) dropped to 4.2% in 2012 and 4.6% in 2013. As the M2 includes M1 plus the money-holding sector’s other bank deposits, an increase in M1 necessarily affects the M2 in the same direction and this has helped drive the M2 growth rate to 6.1% and 5.8% during the last two months. Since 1996, the M1 and M2 money supply have expanded at an annual average pace of 8.0% and 7.2%, respectively.

M1 and M2 Money Supply for Norway, YoY % change
Source: EcPoFi, Statistics Norway

Credit growth stable at 6%+

In September 2006, the one year growth rate in General Public Debt (referred to as C2 Credit by Statistics Norway) in Norway peaked at 15.2%. Three years and three months later, the growth rate bottomed at 2.9% (December 2009). 

General Public Debt in Norway, YoY % change
Source: EcPoFi, Statistics Norway

Since then, the growth rate quickly increased to above 6.0% towards the end of 2010 and has since averaged 6.5%. On a year-end basis, General Public Debt has increased at an annual pace of 8.9% since 1996. As a result, debt outstanding has increased by almost NOK 3.5 trillion, from less than NOK 1 trillion in December 1995 to the current level just shy of NOK 4.4 trillion in January 2014. Of this NOK 4.4 trillion, General Government Debt made up about 9%, Non-Financial Enterprises made up about 33% and Households made up the rest, approximately 59% of the total. This share has been relatively stable based on data going back to the beginning of the data series back in 1987.

Share of General Public Debt in Norway
Source: EcPoFi, Statistics Norway

The Damage caused by Aggressive Credit Growth

Now, what are some of the effects of this massive expansion of money and credit in Norway that has taken
place over many years?
  • a weaker local currency (the Norwegian Krone)
  • higher price inflation of goods and services
  • substantially higher asset prices, especially for housing
  • a lower incentive to save as interest rates have been pushed artificially low due to the aggressive expansion of money and credit, all culminating in
  • an increase in households' debt to income ratio as the former has increased relatively more (see here for more on this).

Perhaps the biggest risk facing the Norwegian economy is the high level of household debt to disposable income which stood at almost 210% at the end of Q3 2013. Few countries on earth can demonstrate a higher ratio. As a result, the economy would be very sensitive to a rise in interest rates. On the other hand, as social benefits are very “generous” in Norway, unemployment levels arguably have a lesser effect on the economy than interest rates. 

A note on Norwegian Banks

While European and U.S. banks are trying to, unsuccessfully (e.g. here), to build capital, the story is even worse for Norwegian banks. They have gotten plenty of attention in the media during the last year or so due to “requirements” to build more capital and to demand more equity from new mortgage applicants (an increase from 10% to 15%). Rune Bjerke, the CEO of DNB, by far the largest bank in Norway, last year made a by now infamous statement that all stakeholder had to contribute towards building the bank’s capital (customers, employees, directors and shareholders). So far, all have contributed, except for directors and shareholders. At least that seems to be the consensus. 

What is noteworthy however is that DNB is not actually really improving its capital position (see bottom table). At 6.0%, the equity to total asset ratio at year end 2013 is unchanged from that reported at year end 2010. Cash and Deposits with central banks as a percent of total assets today stand at 7.0%, equity as a percent of deposits is at 16.4% while Cash and Deposits with central banks as a percent of Deposits is at 19.3%. All are lower than they were two or three years ago. We should also throw in the fact that the bank’s provisions in percent of total bank credit are a very bullish 0.07%. The average since 2005 is 0.16%. For comparison reasons, U.S. banks currently have an equity to total asset ratio of 10.8% (almost twice that in Norway), cash assets in percent of total asset of 19.3% and cash assets in percent of deposits if 27.6%. 

The weak balance sheet of DNB is reflective of the weak consolidated balance sheet of all Norwegian banks which have an equity to total asset ratio of just 6.5%. Despite these poor balance sheets, both the prime minister and finance minister in Norway repeatedly tell us that Norwegian banks are solid (sounds familiar?) No, Norwegian banks are not hard at work strengthening their balance sheets and in my opinion their balance sheets are on average very weak. Norwegian banks' weak balance sheets pose a serious risk to sustainable growth in Norway. In fact, it’s blatantly obvious that Norwegian banks and DNB are betting on being bailed out by Norges Bank (the central bank of Norway) should they need additional financing and short term liquidity. That’s moral hazard and fractional reserve banking for you. Meanwhile the regulators are fast asleep, until next time when Norges Bank will bail the banks out with tax payer money (and those with long positions in the Norwegian Krone). 

M1 and M2 Money Supply for Norway, 5 year growth rates (annualised)
Source: EcPoFi, Statistics Norway

DNB Annual Accounts and Ratios
Source: EcPoFi, DNB