Competitiveness and Regulation of Norwegian Banks. by Karen Helene Ulltveit-Moe, Bent Vale, Morten H. Grindaker and Erling Skanc

Nr. 18 | 2013 Staff Memo Financial Stability Competitiveness and regulation of Norwegian banks Karen Helene Ulltveit-Moe, Bent Vale, Morten H. Grindaker and Erling Skancke Staff Memos present reports and documentation written by staff members and affiliates of Norges Bank, the central bank of Norway. Views and conclusions expressed in Staff Memos should not be taken to represent the views of Norges Bank. © 2013 Norges Bank The text may be quoted or referred to, provided that due acknowledgement is given to source. Staff Memo inneholder utredninger og dokumentasjon skrevet av Norges Banks ansatte og andre forfattere tilknyttet Norges Bank. Synspunkter og konklusjoner i arbeidene er ikke nødvendigvis representative for Norges Banks. © 2013 Norges Bank Det kan siteres fra eller henvises til dette arbeid, gitt at forfatter og Norges Bank oppgis som kilde. ISSN 1504-2596 (online only) ISBN 978-82-7553-781-0 (online only) Competitiveness and regulation of Norwegian banks* Karen Helene Ulltveit-Moea Bent Valeb Morten H. Grindakerc d Erling Skancke 27 November 2013 * We thank Ingvild Svendsen for valuable comments. a University of Oslo b Norges Bank c Morten H. Grindaker was engaged as research assistant in Norges Bank in 2012-2013. d Erling Skancke was engaged as research assistant in Norges Bank in 2012-2013. 1 Contents 1. Introduction ............................................................................................................................ 4 2. The Norwegian banking sector in an international perspective ............................................. 5 2.1. Activity level and growth in the banking sector ............................................................. 5 The size of the banking sector ............................................................................................ 5 The contribution of the financial sector to value added ................................................... 10 Employment in the financial sector .................................................................................. 11 2.2 Profitability in the financial sector ................................................................................. 13 2.3 Compensation in the financial sector ............................................................................. 17 2.4 Cross-country differences in cost efficiency – the case of electronic payment transactions ........................................................................................................................... 18 2.5 Funding structure in the banking sector ......................................................................... 20 2.6 Cross-country differences in market structure ............................................................... 24 3. Norwegian financial sector and banks in a cross-industry perspective ................................ 28 3.1 Activity level and contribution to GDP .......................................................................... 28 3.2 How does remuneration in the financial sector compare to other sectors? .................... 29 3.3 Profitability and equity ................................................................................................... 31 Returns versus equity ratios ............................................................................................. 33 4. Market structure and competition in the Norwegian banking sector ................................... 35 4.1 Market concentration ...................................................................................................... 35 4.2 The nature of competition in the Norwegian banking sector ......................................... 38 Competition from foreign subsidiaries and branches ....................................................... 38 Competition from the bond market .................................................................................. 41 5. Why – and how – banks are regulated ................................................................................. 44 5.1 Why regulate banks? ...................................................................................................... 44 5.1.1 Multiple equilibria when banks borrow short-term and invest long-term .............. 44 5.1.2 Pecuniary externalities ............................................................................................ 46 5.1.3 Moral hazard ........................................................................................................... 48 5.2 Regulatory policies in Norway in a Scandinavian perspective ...................................... 49 5.2.1 Deposit insurance .................................................................................................... 50 5.2.2 Capital regulation .................................................................................................... 51 6. Taxation of the financial sector in Norway .......................................................................... 59 6.1 The tax regime applied to the financial sector in Norway ............................................. 59 Corporate income taxation ............................................................................................... 59 2 VAT .................................................................................................................................. 59 Financial transaction tax ................................................................................................... 60 Stability tax ...................................................................................................................... 60 6.2 Financial sector taxation in other countries .................................................................... 61 Corporate income taxation ............................................................................................... 61 VAT .................................................................................................................................. 61 Financial transaction taxation ........................................................................................... 61 Stability tax ...................................................................................................................... 62 6.3 Financial sector taxation in a national and international perspective ............................. 63 6.4 Implications of the EEA agreement on taxation of the financial sector ......................... 63 7. On the concept of a level playing field................................................................................. 64 7.1 The aim of a level playing field...................................................................................... 64 7.2 For and against a level playing field in banking regulation ........................................... 66 International regulatory spillovers ................................................................................... 67 Different countries – different needs ................................................................................ 68 7.3 Implications for a small open economy ......................................................................... 69 8. Welfare effects of Norwegian bank regulation .................................................................... 70 8.1 Regulatory needs and benefits for Norway ............................................................... 70 8.2 Social costs of relatively stricter domestic bank regulation ........................................... 72 8.2.1 Impact on funding costs .......................................................................................... 72 8.2.2 Impact on product market competition ................................................................... 73 8.3 Financial sector taxation – a lost opportunity? ............................................................... 76 8.4 Concluding remarks ....................................................................................................... 77 Bibliography ............................................................................................................................. 78 Appendix .................................................................................................................................. 82 Appendix to Section 2 .......................................................................................................... 82 Appendix to Section 4 .......................................................................................................... 91 Appendix to Section 6 .......................................................................................................... 92 3 1. Introduction The main purpose of this report is to look at the competitiveness of the Norwegian banking sector, in particular with respect to banking regulation and taxation. How do Norwegian banks perform relative to other European banks and relative to other firms in Norway? Do Norwegian banks have a competitive handicap compared with banks from neighbouring European countries, due to stricter regulation in Norway? And if so, what is the cost of this to the Norwegian economy? The analysis sets out to examine the performance of the Norwegian banking sector in a national and international perspective. We examine the size, growth, compensation and profitability of banks operating in Norway relative to those operating in other European countries and the US. Moreover, we look at performance and compensation in the banking sector

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