There is a close relationship between the central government and the municipal sector in Norway. This relationship is characterised by strict central government control, regulation and oversight of the municipal sector. All municipal budgets must be approved by the central government and municipalities are not allowed to budget for an operating deficit. Borrowings may only finance primary municipal investments and guarantees for third parties are not allowed.
The level of supervision that the local government sector is subjected to is set out in the Local Government Act of 25 September 1992, Section 55, whereby municipalities are prohibited from going bankrupt. They are subject to extensive oversight by the central government. Given the close links and strict supervision of the municipal sector by the central government, it is difficult, if not impossible, for a municipality to become insolvent. The Ministry of Local Government states that, "If a municipality were to run into serious financial difficulties, the Central Government would consider it to be its responsibility to help that municipality and transfer payments could be mobilized on a timely basis". The statement highlights the strong implicit central government support backing the Norwegian municipal sector.
Norwegian local governments receive a substantial part of their income from the central government, directly and indirectly though the local taxation system.
Rating agencies have confirmed the strength of the Norwegian local government sector and the level of central government oversight. In June 2005, Standard and Poor's concluded that the sector is "One of the strongest local government sectors of any country rated by Standard & Poor's". A further stamp of approval came from Moody's in September 2005 when they stated in a report that "Norwegian local governments are among the most regulated and supervised systems in Europe".
With the introduction of the Bank of International Settlement (BIS)'s new capital requirement regulations from January 2007, the Norwegian Ministry of Finance has left its risk weighting criteria with regard to local governments unchanged. Only entities carrying an explicit and unconditional sovereign guarantee are 0% BIS weighted in Norway, unlike other North European countries. This reflects the conservative nature of the Ministry's approach to risk. Local governments are therefore assigned a 20% risk weighting and as such KBN is also 20% risk weighted, corresponding to its ownership structure and its asset base of solely local government risk.