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Financial Stability in Finland: Key Risks and Recommendations

The Finnish banking sector faces several risks that threaten its stability, including disruptions on international financial markets and household indebtedness in neighboring countries. In this article, we will examine these risks, as well as the measures taken to mitigate them, such as stress testing and macroprudential policy.

Banking Sector Risks

The Finnish banking sector is exposed to several risks that could impact its stability:

• Dependence on market funding: The sector’s reliance on market funding makes it vulnerable to disruptions on international financial markets.
• Credit collateralized by immovable property: The use of immovable property as credit collateral adds to domestic tail risks.

Stress Testing

A joint stress test conducted by the Bank of Finland and Financial Supervisory Authority assessed banks’ loss-absorbing capacity against housing market risks. The results revealed:

• A weakened Common Equity Tier 1 capital ratio (CET1), which is a key measure of a bank’s financial health.
• However, banks still exceed minimum capital adequacy requirements, indicating that they have sufficient buffers to absorb potential losses.

Macroprudential Policy

Macroprudential policy aims to reinforce financial system resilience, prevent excessive household indebtedness, and reduce the likelihood of financial crises. In Finland:

• Average structural capital buffer requirements are lower than in peer countries with similar structural risks.
• The use of macroprudential instruments is limited, which could leave banks vulnerable to future shocks.

Pandemic Response

Measures were taken at the start of the pandemic to ease macroprudential policy and ensure continued stability of lending. However:

• Vulnerabilities regarding private sector indebtedness and housing markets continued to grow after the initial shock.
• Large-scale easing measures in macroprudential policy have not been introduced, but some countries are still light on buffers.

Geopolitical Risks

The Russia-Ukraine conflict has added to economic uncertainties:

• Economic sanctions imposed by Western countries could impact Finland’s economy and banking sector.
• The ongoing conflict also creates uncertainty about the future of international trade agreements and global economic stability.

Recommendations

To mitigate these risks, we recommend:

• Increasing macroprudential instruments: This would include more capital requirements that can be eased in the event of financial market disruptions.
• Setting a countercyclical capital buffer requirement above 0%: This would prepare banks for potential future shocks and reduce their reliance on emergency funding.

By taking these measures, Finland’s banking sector can better withstand future economic shocks and maintain its stability.