2.1 Bank of Finland concerned about rising household indebtedness

The Bank of Finland has highlighted the macroprudential risks related to higher levels of indebtedness and has analysed particularly housing company loans and the growth in consumer credit. The Finnish banking sector was reshaped in 2018 by the reorganisation of business activities at Nordic banks.

Finnish household indebtedness has already been rising for a prolonged period. Household debt relative to disposable income has doubled since the 2000, and in September 2018 it stood at 128%.

The majority of household debt is housing-related. The increase in the debt ratio in recent years is due in particular to housing company loans. Their annual growth rate has slowed, but has nevertheless remained higher than that of other household loans, at some 10% in 2016–2018.

Housing loans by credit institutions have grown at an annual rate of some 2% and other housing-related loans by some 4% per annum.

Large percentage of housing company loans must be avoided

Housing company loans can cover as much as 70% of the unencumbered price of a dwelling. Such a large share of housing company loan poses risks particularly for new housing companies that do not make amortisation payments on the loan capital in the early years of the maturity period.

Housing company loans also involve joint and several liability of the housing company shareholders for the servicing of the loans. If a shareholder fails to pay the charge for financial costs, the other shareholders must bear it, in accordance with the principle of joint and several liability. This risk is heightened particularly if investors have financed a large share of the dwellings mainly via housing company loans.

The Financial Supervisory Authority issued a recommendation to credit institutions stating that they should, in the assessment of debtor repayment ability, take into account the impact of potential higher interest rates on the servicing expenses of housing loans.

In addition to financing the sales of new homes, housing company loans are traditionally used in renovations.

Indebtedness involves risks

The majority of consumer credit is granted by domestic credit institutions operating in Finland. Their stock of consumer credit has grown at an annual rate of some 5%.

Consumer credit is provided also by other entities, the largest of which are cross-border foreign entities, so called ‘online lenders’. Thus far the reporting requirements for lenders other than credit institutions are not as tight as those for credit institutions.

The majority of household consumer credit is unsecured, and on average such credit causes credit institutions more problems than housing loans. The size of the consumer credit stock would require up-to-date and comprehensive data that would show the volume and allocation of debt as well as the related risks.

To prevent excessive debt accumulation, authorities are planning a positive credit register, which would provide lenders an overall picture of the customer's financial situation. The register would improve the lender's risk management, while at the same time enhancing households’ ability to manage their finances.

The Bank of Finland has participated actively in a Ministry of Finance working group which was appointed in autumn 2018 with the task of assessing measures for preventing excessive debt accumulation by households and housing companies.

The significance of indebted households is highlighted in the event of a shock to the economy. In an economic downturn, indebted households cut consumption to be able to service their debt.

If the number of indebted households is substantial, this exposes the economy to large fluctuations in consumer demand. A notable decrease in consumption would impact the other sectors of the economy and would, for example, weaken the operating environment for business.

For example, during the 1990s recession, households sought first and foremost to service their housing loans by reducing consumption, which caused loan losses for domestic market companies. Companies, in turn, adjusted their operations via layoffs or redundancies.

The bankruptcies by bank customers resulted in an increase in loan losses, particularly in the corporate sector, and weakened banks’ capital positions, meaning banks had to cut down on lending even more.

Reorganisations in the Finnish banking sector

The Finnish banking sector was reshaped in 2018 by the reorganisation of business activities at large Nordic banks.

Danske Bank merged with its Danish parent company at the start of 2018 and operates in Finland now as a branch and a mortgage credit bank. As a result of the merger, the Finnish banking sector's assets decreased by 10%.

A significantly larger change took place in October, as Nordea transferred its domicile to Finland, making the Finnish banking sector one of the largest in Europe relative to the size of the economy. The purpose of the re-domiciliation was to move Nordea to within the regulatory framework of the Banking Union.

The Finnish banking sector's capital ratios are higher than the EU average, based on indicators applied by the European Banking Authority (EBA). The low risk weights on loans applied by the banks that use internal ratings-based approaches have contributed to the strong capital position of the banking sector.

The leverage ratio of the Finnish banking sector is, however, close to the EU average. The difference is due to the fact that the calculation of the leverage ratio does not take into account risk weights. The banking sector's stock of loans is strong, and the share of non-performing assets is among the lowest in the EU.

Profitability in the Finnish banking sector weakened in the early part of 2018. Profitability was burdened particularly by large IT investments. In addition, net income from investment activities declined. But loan losses remained low. At the end of September, the Finnish banking sector's Common Equity Tier 1 capital (CET1) ratio was 20.4% and the total capital ratio was 22.8%.

The re-domiciliation of Nordea is expected to weaken the banking sector's fourth quarter 2018 CET1 ratio by 3 percentage points. But even then, the Finnish banking sector's capital position is expected to remain notably stronger than the EU average.

Finnish banks, including Nordea, which moved its domicile to Finland, passed the European Banking Authority’s 2018 stress test successfully. The capital adequacy of the Finnish banks that participated in the test was well above the average for the other EU banks. A strong capital position contributes to maintaining banks’ lending capacity.

SME access to bank finance among the best in Europe

The corporate sector debt-to-GDP ratio in Finland has since 2017 remained close to 115%. Credit institutions’ lending to non-financial corporations operating in Finland began to pick up in summer 2018. The annual growth rate of the loan stock of non-financial corporations operating in Finland accelerated notably, and in December it was 5.4%. The average margin of new corporate loans has narrowed slightly.

According to a survey by the European Central Bank (ECB), Finnish SMEs do not have large difficulties in accessing bank loans. The situation has improved since 2017, and in the most recent survey, 88% of the SMEs that had applied for a bank loan reported that they were successful in obtaining the full amount requested or most of it (Chart 8).

Higher risks on the international financial markets

For the international financial markets, 2018 was a more turbulent year than its predecessor. Share market sentiment was subdued and volatility was higher than usual for most of the year.

The key financial stability risk in the euro area was Italy, where growing concerns about the sustainability of sovereign debt triggered a rise in government bond yields in May.

The third major international financial stability risk to Finland was related to risks on the Swedish housing market. The decline in housing prices came to a halt in the early part of the year, but uncertainty remained higher than usual.