EFTA SURVEILLANCE AUTHORITY DECISION

No 205/09/COL

of 8 May 2009

on the scheme for temporary recapitalisation of fundamentally sound banks in order to foster financial stability and lending to the real economy (Norway)

THE EFTA SURVEILLANCE AUTHORITY (1),

HAVING REGARD to the Agreement on the European Economic Area (2), in particular Articles 61 to 63 thereof and Protocol 26 thereto,

HAVING REGARD to the Agreement between the EFTA States on the Establishment of a Surveillance Authority and a Court of Justice (3), in particular Article 24 thereof,

HAVING REGARD to Article 1(3) of Part I and Article 4(3) of Part II of Protocol 3 to the Surveillance and Court Agreement (4),

HAVING REGARD to the Authority‘檚 Guidelines on the application and interpretation of Articles 61 and 62 of the EEA Agreement (5), and in particular the Chapter on the recapitalisation of financial institutions in the current financial crisis: limitation of aid to the minimum necessary and safeguards against undue distortions of competition thereof (6),

HAVING REGARD to Decision No 195/04/COL of 14 July 2004 on the implementing provisions referred to under Article 27 of Part II of Protocol 3 (7),

WHEREAS:

I. FACTS

1. Procedure

On 28 April 2009, the Norwegian authorities notified, pursuant to Article 1(3) of Part I of Protocol 3, a scheme for the temporary recapitalisation of fundamentally sound banks in order to foster financial stability and lending to the real economy (Event No 516522) (8).

2. The objective of the aid measure

The Norwegian authorities have explained that there is considerable uncertainty concerning the evolution of the Norwegian economy and the developments in the banks‘�lending policy and activity. There is a strong interdependence between the real economy and the financial system. The desire to reduce risks in the face of mounting losses may cause banks to tighten the supply of credit. The effect of reduced external demand on the Norwegian economy is exacerbated by a tightening of lending conditions for businesses and households, thereby hampering investments and activity in the real economy and amplifying the negative effects of the general economic downturn.

The Norwegian authorities have indicated that lending surveys carried out by the Norwegian Central Bank (Norges Bank) and the Financial Supervisory Authority (Kredittilsynet) show that banks have been tightening credit standards substantially, particularly for corporate loans. They also show that capital ratios are a key concern for banks when evaluating their lending policy. At present, Norwegian banks are financially sound but they need to strengthen their core capital in order to be able to maintain a normal supply of credit.

In December 2008, Norges Bank recommended that the Government take measures to improve bank solidity in order to enhance lending to the real economy. This recommendation was endorsed by the Financial Supervisory Authority.

The Norwegian authorities have explained that some of the larger Norwegian banks have relatively low core capital ratios and need recapitalisation in order to be able to continue lending to the real economy (9). Smaller banks with high capital ratios may also need additional core capital to maintain or increase lending in line with the purpose of the notified scheme. The Norwegian authorities foresee that certain small banks may have more limited ways of funding themselves and a rather narrow lending portfolio. Accordingly, they are more exposed to liquidity risks than banks with a broader business basis. Thus, even if they originally had higher capital ratios, such factors may imply that core capital is more easily eroded than would be the case for other banks. The Norwegian authorities have accordingly considered that both the situation in the banking sector and the outlook for the Norwegian economy require a state measure offering recapitalisation of fundamentally sound banks in order to restore financial stability and foster lending to the real economy.

The objective of the scheme is to contribute Tier 1 capital (10) to the banks in order to strengthen the banks and to improve the ability of the banks to maintain ordinary lending activities. The scheme is only open for fundamentally sound banks and has, according to the Norwegian authorities, been designed to achieve the purpose of ensuring lending to the real economy, whilst minimising distortions of competition.

Under the recapitalisation scheme, a Government Finance Fund (Statens finansfond) (11) has been set up with the purpose of temporarily contributing Tier 1 capital to Norwegian banks (12): acquisition by the Fund of either hybrid securities or preference capital instruments shall be based upon an application from the individual bank. The conditions shall be governed by an agreement between the Fund and the individual bank, setting out the exact modalities of the recapitalisation (e.g. nominal value, amount, remuneration and exit incentives).

3. National legal basis for the aid measure

The national legal basis establishing the Fund is Lov 6. mars 2009 nr. 12 om Statens finansfond. An implementing regulation relating to the Fund and its activities will also be adopted (13).

4. Budget and duration

In 2008, Norges Bank carried out a macroeconomic stress test for the six largest Norwegian banks. The test replicated a negative scenario where the outcome was that banks would record losses amounting to on average 2,3 % of their risk-weighted assets. On the basis of this test, Norges Bank estimated the need for recapitalisation of the ten largest banks to be NOK 34 billion. In accordance with the results of this test, sufficient resources (NOK 50 billion, approximately 5,1 billion EUR) have been allocated to the Fund.

The scheme shall be of a temporary nature and the rules are expected to enter into force in May 2009, with a window of 6 months for the Fund to reach agreements with banks that apply for recapitalisation. The deadline for submitting applications to the Fund will be set 6 weeks prior to the expiry of that 6-month period in order to give the Fund time to conclude an agreement with the applicant bank before the window closes in November 2009. Within this time period, the Norwegian authorities will also evaluate whether the measure would be needed for a longer period, in which case the scheme will be re-notified.

5. The recapitalisation scheme

5.1. The beneficiaries

The Norwegian authorities have explained that only Norwegian banks that are financially sound are eligible for aid under the notified scheme.

The Norwegian Financial Supervisory Authority will exercise a gate-keeping function and determine whether a bank is eligible under the scheme (14). As part of its regular surveillance functions, the Financial Supervisory Authority receives from each bank information on loan portfolios and other elements of its balance sheet, business plans and their own assessment of future risk factors. When a bank applies to the Fund for a capital injection, the Financial Supervisory Authority will be asked to make an assessment as to the bank‘檚 eligibility under the scheme. The test, according to Section 2 of the Regulation, is that ‘the bank meets the Tier 1 capital ratio requirement with a good margin, also when likely developments in the near future are taken into consideration‘� According to the Norwegian authorities, the Financial Supervisory Authority will presume that this requirement is met if the bank in question has a core capital ratio at or above 6 %, i.e. 2 percentage points above the regulatory minimum requirement. In all cases, the Financial Supervisory Authority shall base its analysis on up-to-date information, taking into account a bank‘檚 various risk exposures, asset quality, and business prospects, as well as the formal capital adequacy ratios, in order to conclude that a bank is fundamentally sound also in light of likely developments in the near future.

5.2. Maximum capital increases

Maximum limits for increases in core capital ratios through capital injections from the Fund are foreseen as follows:

Banks which will have a core capital ratio in excess of 12 % after the state capital injections shall document their need for a capital contribution and the Fund will assess the case in light of the bank‘檚 situation and in light of how lending to the real economy may be stimulated.

Likewise, an application for an increase in core capital of more than 2 percentage points must include appropriate documentation justifying the need for such a large injection of capital.

The Fund will decide on the actual amount to be allocated on the basis of an assessment of various risk factors, business plans and prospects. The Norwegian authorities have explained that if the Fund is not convinced, on the basis of the evidence provided, that there is a need for any aid under the scheme, it will reject the application. Banks placed in the highest risk category that request a capital increase of more than 2 percentage points will be subject to particular scrutiny.

Cases where the recapitalisation will correspond to more than 2 % of the core capital ratio will be reported to the Authority.

5.3. Assignment to a risk class

The Fund shall assign each bank to one of three risk classes, based on objective criteria (16). The risk class will determine the coupon to be paid on capital injected by the Fund and will remain fixed for the duration of the agreement between the bank and the Fund.

The Regulation stipulates that banks with an external rating from an authorised credit rating agency shall be assigned to a risk class as follows:

The Norwegian authorities have explained that few Norwegian banks are rated by international rating agencies. Other banks are, however, rated regularly by the largest Norwegian banks. Banks that are not rated by an authorised credit rating agency will be assessed according to principles similar to those applied by official credit rating agencies (17).

The Norwegian authorities estimate that very few Norwegian banks will fall within risk class 1, a number of banks will fall within risk class 2, and the majority of banks will be assigned to risk class 3 (around three quarters of all Norwegian banks).

5.4. Recapitalisation instruments

The legislation provides for two alternative capital instruments, a Hybrid Tier 1 security (‘�span class="italic">fondsobligasjon