Bloomberg News

Norway to Cut Bank Support as Europe Girds for Deeper Crisis

September 29, 2011

(Updates with Norway, German 10-year bond spread, DnB NOR shares in fifth paragraph.)

Sept. 29 (Bloomberg) -- Norway’s central bank will force lenders to wean themselves off its deposit facility in an effort to spur interbank lending even as Europe’s debt crisis threatens to trigger a region-wide liquidity squeeze.

“Norges Bank wants the banks to use each other more for placing their money,” Kari Due-Andresen, an analyst at Svenska Handelsbanken AB in Oslo and former central bank economist, said in an interview. “But what the banks say is that at the moment the situation is so insecure and they are hoarding their own cash, so the new measures will just make things worse.”

Norges Bank will impose a quota on bank reserves starting next month, seeking to cap the total amount left with the central bank at 45 billion kroner ($7.9 billion) a day in an effort to force lenders to rely on each other for funds and help reduce interbank spreads. That’s unlikely to work as the prospect of European bank losses amid a deepening debt crisis prompts lenders to shun the interbank market and forces spreads even wider, according to Due-Andresen.

Reluctance amongst Europe’s banks to lend on the interbank market is the highest in more than 2 1/2 years, market rates indicate. The Euribor-OIS spread, the difference between the three-month European interbank offered rate and overnight index swaps, rose this week to 91 basis points, the highest since March 18, 2009, Bloomberg data show.

Substantial Stresses

The difference between the central bank’s deposit rate and the three-month Norway interbank offered rate widened to 84 basis points this week, versus a May low of 43. Market expectations derived from forward contracts show the policy rate at 2.06 percent in three months, widening the Nibor spread to 100 basis points, according to Kyrre Aamdal, a senior economist at the country’s biggest bank.

The central bank said the wider spread isn’t enough to force it to reconsider the deposit quota, first announced in October last year.

“Of course if there should be substantial stresses in the system, we will as always address those issues when they arrive,” said Kristine Falkgaard, director at Norges Bank’s department for market operations and analysis, in an interview. “But up until now we still believe that the market situation is not such that it will alter our announced plans in terms of the size of the quotas and the reserves.”

Spread Widens

The difference in yield on Norway’s 10-year bonds and similar-maturity German bunds widened four basis points today to 41, the biggest jump in a week. Shares in DnB NOR lost as much as 1.3 percent before trading down 0.3 percent at 58.65 as of 9:41 a.m. in Oslo.

Lenders exceeding the central bank’s deposit quota will be forced to accept a rate that’s 100 basis points lower than the deposit rate, which has been at 2.25 percent since May 12. The 45 billion-krone cap on the daily quota is 30 percent less than the daily average banks have deposited with the central bank this month through Sept. 22.

“The new system imposes a cap on total liquidity in the Norwegian money market and this cap is lower than what has been deemed necessary in the last few weeks,” said Gaute Marius Langeland, a senior analyst at Nordea Markets in Oslo. “Banks will end up with less liquidity under the new regime.”

Europe’s banks are struggling to stay profitable as they face losses on sovereign debt holdings and as tougher global regulatory standards force them to raise capital buffers. In the euro area, the European Central Bank has responded by boosting liquidity, amongst other things through a dollar lending facility.

Norway Stands Out

Norges Bank’s plan to impose bank deposit quotas in this environment “definitely stands out from the rest of the world at the moment,” Erica Blomgren, chief strategist for Norway at SEB AB, said in an interview. “You have so much uncertainty right now in the markets regarding the debt crisis, regarding new regulations and this adds an element of uncertainty.”

The country’s bankers organization, Finance Norway, is “a bit skeptical” toward the central bank’s plan, said Arne Hyttnes, the group’s managing director. “We don’t like it, but we can see the argument to get a better functioning interbank market,” he said.

While policy makers want to force banks to normalize interbank lending by relying more on each other, market stresses may be too severe now to allow such measures.

Finding Alternatives

That means the central bank’s quota won’t succeed in reducing interbank spreads, according to Aamdal. What’s more, “small banks often use deposits to fulfill their liquidity requirements,” he said. “With a low quota it may be difficult to find other liquidity instruments.”

Norway’s financial system may also come under pressure as the country faces a housing market bubble, according to Morten Baltzersen, the head of the country’s Financial Supervisory Authority.

Norway’s $524 billion sovereign-wealth fund has so far shielded the country from the worst of Europe’s debt crisis. Still, adding to bank industry stresses as household indebtedness soars to the highest in more than two decades may stall recovery prospects. The central bank estimates consumer burdens will grow to more than 204 percent of disposable income next year, the highest since at least 1988.

Norway in the early 1990s seized control of its biggest banks, in part because of a real estate slump that followed a surge in lending growth triggered by deregulation in the 1980s.

The central bank kept its benchmark interest rate unchanged for a third consecutive meeting on Sept. 21 and signaled it may postpone planned rate increase until next year as policy makers respond to the risk of a deepening European debt crisis.

--Editors: Tasneem Brogger, Jonas Bergman.

To contact the reporter on this story: Josiane Kremer in Oslo at jkremer4@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net


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