Reflections on Credit Market Incentives in a Small Open Economy with a Dominant Market Player: The Case of Norwegian Banking

Abstract

This paper reflects on the banking market in Norway, a small open economy with a market player that is “too big- and too public to fail” (TBTPF). Discussing competition, risk and regulation, this paper reflects on market characteristics relevant for banking in other small open economies. Targeting the mortgage market, the dominant player contributes to credit­ driven housing appreciations, which, when combined with floating mortgage rates, represents the main component in any financial stability assessment. The market share of foreign branches and subsidiaries, institutions not fully regulated by the Norwegian FSA, also contributes. The potential for a flight-home effect during a crisis might be the strongest risk contribution from foreign banking. In this respect the deviation from the single rulebook in Norwegian regulation is a paradox, as the risk shifting incentives created may contribute to a credit-crunch and be an ex post threat to financial stability.