3.2 COVID-19 pandemic required exceptional measures to maintain financial stability

During the COVID-19 year 2020, the Bank of Finland was involved in active cooperation with the other authorities responsible for financial stability. The objective was to prevent adverse economic impacts from the pandemic and to enhance the provision of credit. The Bank continues its work to strengthen the financial system and develop the macroprudential toolkit.

In 2020, authorities globally sought to mitigate the negative impacts of the COVID-19 pandemic on the economy by several measures in the area of central banking, macroprudential policy, banking supervision and regulation. The objective was to maintain the stability of the financial system and lending to businesses and households, thereby helping them cope with the sudden loss in income.

The aim was also to enhance the effectiveness of monetary and fiscal policy measures and to prevent the adverse longer-term effects of the pandemic on the economy. The Bank of Finland participated in both domestic and international cooperation.

The pandemic required rapid action and tighter cooperation

On the back of the regulatory changes introduced after the financial crisis, the ability of banks to cope with difficulties was considerably better on the outbreak of the COVID-19 pandemic than at the onset of the financial crisis.

In 2020, banks’ capital and liquidity positions were stronger than before.

The larger capital buffers and the possibility to use them improved banks’ ability to absorb losses and continue lending to businesses and households despite the sudden weakening in the economic outlook.

European banking and macroprudential supervisors acted rapidly in the spring. The SSM, the ECB’s banking supervision framework, allowed its directly supervised banks temporary flexibility in meeting certain additional capital and liquidity requirements. Banks were also allowed, for example, to use flexibilities in loan loss provisioning.

National supervisors granted similar flexibilities to smaller banks under their supervision. European banks followed widely the recommendations by supervisors to temporarily refrain from dividend distributions.

In addition, implementation of the global capital and liquidity requirements for banks (the finalisation of Basel III) was deferred for a year.

The pandemic further tightened domestic and international cooperation between authorities. The Bank of Finland participated actively in, for example, the COVID-19 working groups of the European Systemic Risk Board (ESRB) and the ECB. The European Systemic Risk Board is responsible for macroprudential oversight of the financial system.

Macroprudential policy supported lending

The macroprudential policies introduced in the wake of the global financial crisis faced their first test as a result of the outbreak of the COVID-19 pandemic.

In Europe, many national macroprudential authorities eased banks’ capital buffer requirements or reversed earlier tightening.

Measures by banking and macroprudential authorities freed up banks’ capital for maintaining provision of credit and absorbing losses.

In Finland, decisions on macroprudential measures are taken by the Board of the Financial Supervisory Authority (FIN-FSA). The Bank of Finland participates actively in macroprudential policy preparations, impact assessments and the development of macroprudential tools.

In 2020, the Board of the FIN-FSA took decisions to ease macroprudential policy.

In April, the capital buffer requirements determined on the basis of structural characteristics of the financial system were eased by one percentage point for all credit institutions. Structural macroprudential buffers are set primarily to limit serious financial sector-related problems in the banking sector in a crisis.

The purpose of the measure was to mitigate the negative impact of the COVID-19 pandemic on financial market stability and to promote credit institutions’ ability to provide credit.

This, together with the decisions of the macroprudential supervisors of other countries, was estimated to increase the lending capacity of credit institutions to Finnish businesses and households by some EUR 30 billion.

In June, the FIN-FSA Board restored the maximum loan-to-collateral ratio, i.e. the loan cap, to its statutory base level.

On the base level, the maximum loan-to-collateral ratio for residential mortgage loans other than first-home loans is 90% and for first-home purchases, 95%.

The decision supported the proper functioning of the housing market in an economic environment altered by the pandemic.

Without these policy measures, the financial sector may have reinforced the weakening of the real economy, as the slowing of lending activity would have pushed the real economy into an even deeper recession.

In September 2020, the FIN-FSA Board decided not to extend the validity of the risk weight floor for residential mortgage loansBanks’ capital requirements are expressed as a percentage of a bank's risk-weighted assets. The total amount of risk-weighted assets is calculated by multiplying the individual exposures, for example loans, by their risk weights before totalling up the overall exposures. The smaller the risk weight of an item, the smaller the amount of capital the bank must set aside for that asset. The risk weight floor set a minimum average risk weight of 15% for residential mortgage loans., which entered into force in 2018. The macroprudential significance of the risk weight floor has declined and will continue to decline as a result of supervisory measures and regulatory changes.

The FIN-FSA Board also urged lenders to exercise restraint in granting loans that are very large in relation to the applicant’s income and have longer maturities than usual.

In addition, the FIN-FSA Board decided each quarter on the level of the countercyclical capital buffer (CCyB) and kept the rate at 0%.

Supported by the extensive policy measures, the financial system withstood the test caused by the outbreak of the pandemic in 2020, but in the long term the weakening of the economic outlook is likely to increase credit losses.

Unemployment benefits, business subsidies and public guarantees are, however, expected to dampen the growth in losses somewhat.

The Bank of Finland participates in the development of macroprudential instruments

The COVID-19 pandemic demonstrated the need to ensure that macroprudential policy can be conducted in accordance with the economic cycle.

The objective of the design and stance of macroprudential policy in the immediate years ahead is to support the sustainable recovery of the economy and the financial system.

The reform of banking regulation will introduce more clarity and flexibility to the use of macroprudential buffers in 2021. The regulatory reform, i.e. the Banking Package, will also implement within the EU some of the post-financial crisis reforms of banking and financial regulation agreed on a global level.

The Bank of Finland participated actively in the work to incorporate the Banking Package in Finnish legislation.

In its stated opinion, the Bank of Finland highlighted the importance of the reforms included in the Banking Package for safeguarding financial stability and supported, in particular, the proposals related to the maximum level and principles for setting of the macroprudential capital buffer requirements.

Bank of Finland experts also issued opinions to, for example, Parliamentary Committees on other issues related to financial regulation, such as securitisation and the common backstop of the Single Resolution Fund.

Bank of Finland experts have also promoted the macroprudential measures proposed by the Ministry of Finance working group on household indebtedness.

The legislative proposals being prepared based on the working group's recommendations will be presented in 2021.

The positive credit register, once finalised, will facilitate the use of borrower-based macroprudential instruments.

The Bank of Finland participates in the work to extend the macroprudential toolkit outside the banking sector, particularly to funds and the insurance sector.

Digitalisation will change and increase the provision of financial services. The European Commission adopted in 2020 a digital finance strategy, the objective of which is, among other things, to ensure a level playing field for financial market participants.

The Bank of Finland contributed to the assessment of financial market digitalisation also from the perspective of financial stability.

Strengthening the banking system and development of the Capital Markets Union increasingly important

The COVID-19 crisis has highlighted the need to further develop and strengthen the European banking system. Key to this work is the completion of the European Banking Union.

As regards finalisation of the Single Resolution Mechanism, which is part of the Banking Union, the euro area ministers of finance agreed in 2020 to advance introduction of a common backstop to the Single Resolution Fund (SRF).

The backstop will facilitate the restructuring of distressed large banks without threatening financial stability.

For the diversification of the bank-centred European financial system, it is also important to continue development of the capital markets.

The European Commission adopted in autumn 2020 a new action plan for the Capital Markets Union.

Development of the capital markets would improve in particular companies’ access to finance and diversify risks. Development of the markets for Green Finance would also promote achievement of the EU's climate objectives.