Financial stability risks must be identified in good time – Bank of Finland's Annual Report 2019

The Bank of Finland assesses risks and vulnerabilities that could threaten the stability of the financial system. In 2019, the Bank focused most especially on household indebtedness, the real-estate market, the structure of the credit institution sector, climate change and digitalisation.

The Bank of Finland publishes regular analyses of vulnerabilities in the Finnish financial system, as well as on domestic and international risks to financial stability, in its financial stability assessment.

In 2019 the Bank of Finland focused its attention on household and corporate debt, measures for preventing the excessive build-up of household debt, residential and commercial property markets, financial sector digitalisation, and the profitability of the European banking sector.

The Bank of Finland analysed the risks of indebtedness and the real estate market in Finland

Financial stability risks in Finland are tightly connected with the country’s property market. Data compiled by the Bank of Finland and Statistics Finland show that some two thirds of loans granted by Finnish credit institutions to households and non-financial corporations are used for the purchase, repair, maintenance or construction of residential or commercial real estate.

Real estate-linked loans include households’ loans for house purchase (e.g. mortgages), housing company loans held by shareholding households, other loans granted to housing corporations, and loans held by real estate and construction sector companies (Chart 9).

Chart 9.

Some two-thirds of loan volumes linked to real estate market

Finnish household indebtedness has reached a level of concern. Household debt has grown unambiguously faster over the long term than income available for consumption, savings and debt-servicing.

Housing loans and housing company loans have grown and their maturities lengthened. Consumer credit has increased in volume, and there is a growing variety of domestic and foreign consumer loans available.

The Bank of Finland stressed in 2019 that high levels of household debt interfere with the economy’s ability to adjust to severe disruptions. If households see their debt-servicing costs rise or incomes decline, they often cut back on their consumption first, so that they may continue to service their debts and accumulate savings for even rainier days still. A significant decline in consumption during a downturn would have far-reaching consequences for the economy (Chart 10).

Chart 10.

The Bank of Finland assesses vulnerabilities in the credit institution sector and international risks

The Bank of Finland analysed risks related to lending and the structure of the credit institution sector in two macroprudential reports (in Finnish), which it published in collaboration with the FIN-FSA in 2019. These and other macroprudential assessments by the Bank of Finland provide support to the FIN-FSA Board on decisions on the deployment of macroprudential tools.

Indicators published in the macroprudential reports and the Bank of Finland's chart gallery show that the structural vulnerability of the Finnish credit institution sector is higher than that of the other EU credit institution sectors on average. In addition, several indicators point to an increase in vulnerability.

The structural risks identified by the Bank of Finland are large exposures in residential and commercial real estate loans; dependence on market-based funding; the large size, degree of concentration, and interconnectedness of the credit institution sector; the significant role of credit institutions as providers of finance to the private sector; and indebtedness levels in the largest customer groups, i.e. households and non-financial corporations (Table 1). Dependence on market-based funding is due to the structural funding gap, i.e. the fact that the volume of lending is considerably larger than deposit funding.

Table 1.
Structural indicators – comparison of Finnish findings with the median for EU Member States and the average of Finnish findings
Indicator	EU comparison	Finnish history
1. Housing loans granted to domestic households as proportion of total loans granted by the credit institution sector to the private sector	Higher	Higher
2. Credit institution’s claims on construction and real estate companies as a proportion of credit institutions’ total assets	Higher	Higher
3. Credit institutions’ domestic government bond assets relative to credit institutions’ total assets	Not higher	Not higher
4. Domestic credit institutions’ interbank deposits as a proportion of the total liabilities of the credit institution sector	Not higher	Not higher
5. Funding deficit of the credit institution sector in various countries	Higher	Higher
6. Combined balance sheet total of foreign banks’ subsidiaries and branches relative to gross domestic product in various countries	Higher	Not higher
7. Balance sheet of the credit institution sector relative to nominal gross domestic product	Higher	Not higher
8. Combined balance sheet of the five largest credit institutions relative to the aggregate balance sheet of the entire credit institution sector	Higher	Not higher
9. Loans granted by domestic credit institutions to households and non-financial corporations as a proporion of households’ and non-financial corporations’ total liabilities	Higher	Higher
10. Household sector’s liabilities relative to households’ disposable income	Higher	Higher
11. Non-financial corporations’ indebtedness relative to gross domestic product	Higher	Higher
Sources: European Central Bank and Bank of Finland calculations.

The Bank of Finland analyses risks in the global financial system

The Bank of Finland regularly analyses risks to the global financial system that could have an impact on Finland, either through the real economy or the financial markets. In 2019, this analysis focused on the markets for housing and corporate finance in the United States, potential problems related to the sustainability of general government and private sector debt in the euro area, and the weak profitability of European banks.

The analysis of international risks also focused on Nordic banks and their interconnectedness. Large Nordic banks share similar risks related to liquidity and funding, and they have each granted a large volume of loans for house purchase. Possible disruptions could spread across countries not only via banks but also multilateral trade.

In 2019, the Bank of Finland participated in a joint banking crisis simulation exercise concerning large cross-border banking groups. The exercise was conducted by Nordic and Baltic financial stability authorities, and involved national or competent authorities from European countries. The exercise followed a hypothetical crisis scenario involving fictitious financial institutions, and it tested the cooperation and crisis management capabilities of central banks, financial supervisors, ministries of finance and resolution authorities.

The Bank of Finland participated in the debate on climate change and new technologies

Bank of Finland experts wrote several articles and blogs in 2019 on topical issues in the area of financial stability. The key themes were climate change, artificial intelligence (AI), big data, means for predicting and preventing financial crises, and access to finance by SMEs in Finland.

The Bank of Finland organised three international conferences in 2019 that focused on topical issues in financial stability.

In October, the Bank of Finland and the Ministry of Finance co-organised the conference Greener Finance for Sustainable Future. The conference discussed proposals for sustainable finance as well as climate and environmental issues involving the financial markets. Climate change poses a risk for financial stability not only because of the potential for direct financial losses but also because of the transition risks caused by changes in business models.

In December, the Bank of Finland organised the conference Data Driven Financial Stability: Opportunities and Challenges in Big Data. The conference addressed, among other topics, the ways in which artificial intelligence (AI) and big data are changing financial markets. Digitalisation can improve efficiency, but innovations may also expose markets to new vulnerabilities.

The Bank of Finland also organised, in cooperation with the European Systemic Risk Board and RiskLab Finland, the Systemic Risk Analytics conference, for the fifth time already. The conference focused on methods designed for analysing threats to financial stability.