2.2 Bank of Finland participated in the preparation of tools that support financial stability

In 2019, the Bank of Finland supported financial stability by preparing macroprudential decisions and developing new tools that improve financial stability.

Macroprudential instruments are designed to reduce the likelihood of financial crises and mitigate their impact on the financial system and the macroeconomy.

Macroprudential instruments not tightened in 2019

Finnish authorities did not deem it necessary to tighten their existing macroprudential instruments in 2019, based on the macroprudential analyses conducted over the year. However, the systemic risk buffers imposed in the summer of 2018 did not enter into force until 2019.

In Finland, all decisions on the deployment of macroprudential tools are taken by the Finnish Financial Supervisory Authority (FIN-FSA) Board. The Bank of Finland participates in the preparation of these decisions. The Bank of Finland also participates in macroprudential decision-making and cooperation in the euro area and in the European Union.

The countercyclical buffer requirement for credit institutions mitigates systemic risk stemming from the credit cycle. The FIN-FSA Board decides on the activation of the countercyclical buffer on a quarterly basis. The Bank of Finland participates in the preparation of the analysis underpinning these decisions.

Early warning indicators and an overall assessment do not point to an overheating of the credit cycle or other reasons for tightening the countercyclical buffer requirement. The FIN-FSA Board therefore left the requirement unchanged, at 0%, in 2019.

There are structural risks in the Finnish financial system

The systemic risk buffer is an additional capital requirement that can be imposed on credit institutions on the basis of structural risks in the financial system. In Finland, these risks are especially the high level of household indebtedness, the credit institution sector’s high degree of concentration and role in financial intermediation, and the interlinkage between the Finnish financial system and the financial systems of the other Nordic countries.

The FIN-FSA Board decided in June to extend the period of application of the credit institution-specific systemic risk buffer requirements imposed in 2018.

In spring 2018, the maximum loan-to-collateral (LTC) ratio was lowered to 85% for residential mortgage loans other than first-home loans. This was due to the high level of household indebtedness. The revised LTC requirement entered into force in July 2018.

Indebtedness rose throughout the 2010s and is now record high. The decision on the application of the lower LTC ratio must be reviewed on a quarterly basis. In 2019, the period of application was extended in each quarter.

In June 2019, the FIN-FSA Board decided to retain the minimum level of 15% for the average risk weight on residential mortgages for credit institutions using the Internal Ratings Based Approach. Studies show that risk weights on residential mortgage loans applied by credit institutions in their internal models are relatively low and do not adequately address all the second-round effects stemming from the residential mortgage loans and amplifying the shocks to the economy.

Bank of Finland experts participated in the preparation of all the macroprudential decisions. Moreover, the Board of the Bank of Finland delivered opinions on proposals by the Director General of the FIN-FSA on macroprudential decisions.

The Bank of Finland participated in the Ministry of Finance working group on indebtedness

The Ministry of Finance appointed a working group in autumn 2018 tasked with assessing measures to combat the excessive accumulation of debt by households. The Bank of Finland took an active role in this work. In October 2019, the working group completed its task and published a report (in Finnish) on its findings.

The working group proposed that a maximum debt-to-income (DTI) ratio be added to the macroprudential instruments available to Finnish authorities. The DTI ratio would limit the total amount of household debt relative to annual income. Thus, the calculation of the maximum DTI ratio would include not only housing loans but also consumer credit and student loans. The working group proposed that the maximum DTI ratio be set to 450%, i.e. total debt could be 4.5 times a household’s gross annual income (Chart 11).

To curb overall indebtedness, the working group also considered it important to restrict the lengthening of loan maturities. The working group proposed a maximum maturity for housing loans, which would be 25 years at the date of loan origination.

In recent years there has been a disconcerting rise in housing company loans. The working group therefore proposed a limit on the maximum amount of credit issued to housing companies for new-build construction, i.e. a maximum credit share. It would be set at 60% of the unencumbered price of the flats to be sold.

The working group also proposed that the frequently used interest-only periods be prohibited for five years from the completion of the dwelling. As housing loans, housing company loans would be subject to a maximum maturity requirement of 25 years. 

The Bank of Finland considered the working group proposals useful

The Bank of Finland issued an opinion (in Finnish) on the working group’s report. The Bank shared the working group's assessment that the toolkit for curbing excessive growth in credit and indebtedness should be extended. The Bank of Finland also considered the tools proposed by the working group as appropriate for this purpose.

The structure of household debt has changed and the importance of lending by non-banks has increased. The proposed tools should therefore be applied to both credit institutions and other lenders. The tools should be applied not only on housing loans but also housing company loans and consumer credit.

In its opinion, the Bank of Finland also cautioned that tighter credit standards may weaken households’ ability to smooth consumption over time.

On the other hand, the proposed measures would also strengthen the resilience of households and lenders, mitigate systemic risks related to excessive indebtedness and could decrease the likelihood and severity of financial crises.

The proposed tools have an impact on both households and the macroeconomy. It is therefore important to extend and develop the assessment of their appropriateness and impact.

European Systemic Risk Board issued Finland a recommendation to prevent vulnerabilities in the residential real estate sector

In September 2019, the European Systemic Risk Board (ESRB) issued Finland a recommendation on the activation of borrower-based macroprudential measures. The activation of new measures would be necessary for preventing medium-term vulnerabilities in the residential real estate sector.

The Bank of Finland shares the ESRB’s views that vulnerabilities in the housing market must be reduced. The Bank of Finland takes the view that activation of the tools proposed by the Ministry of Finance working group on indebtedness would fulfil most of the recommendations issued by the ESRB.

The Bank of Finland participates in the development of Capital Markets Union

The development of a single market for capital in the EU started in 2015 already, but with the election of the new European Commission, the development work entered a new gear. In its own assessments in 2019, the Bank of Finland identified three areas of development in the Capital Markets Union that demand further progress.

The areas identified are: activation of retail investors, development of markets for green bonds, and creating a safe asset. This would weaken the ‘vicious circle’ (also known as the ‘doom loop’) between banks and sovereigns. In addition, the Bank of Finland takes the view that, in future, it would be important to set clear priorities for the development work, instead of seeking to promote all the initiatives all at once.