3.1 A curb on household debt accumulation supports financial stability

The Bank of Finland assesses regularly risks and vulnerabilities that threaten the stability of the financial system. Currently, they relate particularly to the upward trend in household debt accumulation. In 2021, the Bank of Finland paid close attention to the vulnerabilities stemming from housing finance. The continued growth in indebtedness and the related risks should be curbed by introducing new macroprudential instruments.

The Bank of Finland has stressed for a long time that the vulnerabilities related to housing and housing company loans as well as to the continued upward trend in household indebtedness are large in Finland.

The Bank of Finland emphasised in 2021 that new targeted instruments should be introduced without delay to curb household debt accumulation.

These instruments could include, for example, a maximum debt-to-income ratio, i.e. a debt cap and a limit on the maturities of housing and housing company loans. The debt-to-income cap would curb growth in household indebtedness relative to income.

The instruments should apply to all types of credit provision, including lending by non-banks.

Housing loans increasingly with longer maturities

Household debt relative to disposable income continued to rise during the COVID-19 pandemic, and debt levels are record high. In addition, the maturities of housing loans are longer than ever.

The share of new housing loans with maturities of over 26 years has risen gradually in recent years, including in 2021 (Chart 16).

At the same time, the share of loans with initial maturities of less than 20 years has shrunk, accounting for only just over a fifth of new housing loans.

A Bank of Finland analysis shows that new mortgage borrowers have an increasing amount of debt relative to income. The results are based on loan-specific data on new mortgages compiled by the FIN-FSA from credit institutions. Debt-to-income ratios are higher than average in Finland’s growth centres.

Calculations by the Bank of Finland showed that, considering the housing loans granted in recent years and borrowers’ other debt, a neutral debt-to-income ratio would be some 500% of borrowers’ gross annual income. This means that the housing loans granted recently could be granted also if the debt cap was set at 500%.

The calculations were based on the assumption that creditors would have significant room for discretion, so that the debt-to-income cap could be exceeded by 15% relative to the total euro volume of new housing loans.

A debt cap could dampen cyclical fluctuations

The Bank of Finland also examined, using the Bank of Finland's general equilibrium model, the possible economic impacts of the introduction of a debt-to-income cap. Based on the results, the impact on long-term economic growth would be moderate.

A debt-to-income cap might, however, dampen economic fluctuations relative to the current loan-to-collateral constraint.

A loan cap useful also in housing company loans

The Bank of Finland monitored in 2021 developments in housing company loans and supported proposals for imposing a loan-to-value (LTV) limit, or a maximum credit share of 60% for housing company loans and for discontinuing the granting of interest-only periods for loans related to new housing construction.

These reforms would curtail household debt accumulation and would affect mainly the financing of new owner-occupied housing construction.

Households’ need for housing loans could increase if a housing company loan would make up a smaller share of the unencumbered price of the new build. This would, however, help borrowers assess more accurately the total costs of housing.

Bank of Finland data on the domestic housing market became more comprehensive in 2021 as buy-to-let mortgages were separated from other housing loans.

The average interest rate applied on new buy-to-let mortgages is slightly higher than on residential mortgages, but lower than the average rate applied on housing company loans.

Own stress test framework takes into account Nordic interconnectedness

The Board of the FIN-FSA did not increase the macroprudential buffers of domestic banks in 2021, but the Bank of Finland conducted extensive analyses to improve preparedness for the appropriate dimensioning of the buffers in future.

The Bank of Finland and the FIN-FSA developed jointly a stress test framework, which complements the European stress test exercises of banks.

A proprietary stress test exercise provides useful information on banks’ loss-absorbing capacity in the event of a severe disruption in their operating environment.

The stress test framework takes into account that Finnish banks have business activities in the other Nordic countries, enabling the assessment of exposures to the business cycle of the other Nordic countries.

Due to Nordic interconnectedness, the Bank of Finland promoted in 2021 the analysis of contagion risks between banks in Finland and the other Nordic countries. A contagion risk analysis provides information on the possible chains of contagion and their impacts on the banking sector.

Fewer interest-only periods in the corporate sector

In 2021, the Bank of Finland analyses focused in particular on how Finnish companies have coped with the pandemic.

Despite the growth in corporate credit-related risks to banks, average lending rates did not rise significantly. ln 2021, there was less need for interest-only periods and for changes to loan repayment programmes than in spring 2020. Moreover, the worst fears concerning loan loss developments did not materialise.

The stock of loans to Finnish non-financial corporations contracted for several consecutive months in 2021, which may be an indication that companies’ investment activity has not yet fully recovered from the impacts of the pandemic.

Diverse new datasets becoming available

As in the previous year, the Bank of Finland participated in 2021 in the preparations for a positive credit register. The plan is to enter into the register data on Finnish households’ credit and income.

The initiative is part of the Government's efforts to curb excessive debt. From the perspective of financial stability, the positive credit register will enable a more comprehensive, transparent and thus reliable monitoring of the credit market. Based on current information, the register will be launched in 2024.

The Bank of Finland and Statistics Finland worked on their joint analysis initiative, the purpose of which is to combine the Bank of Finland's data on corporate credit with Statistics Finland’s statistical data on businesses. The actual analysis phase of the project will start in 2022.

Stability analysis was enhanced in 2021 also with the help of IT solutions that improve the availability of the extensive datasets employed by the Bank of Finland.

As a result of these changes, various reports will be automated and enhanced, which will also make the Bank of Finland's work more visible on its website.

International analysis focuses on housing markets

In all the Nordic countries, banks typically have large volumes of housing loans in their portfolios, and therefore a steep decline in housing prices could cause considerable credit losses and affect the availability and cost of funding for the banks.

Housing prices have, however, risen strongly during the pandemic both in Finland and elsewhere in Europe (Chart 17). This may further aggravate the financial stability vulnerabilities related to household indebtedness and banks’ real estate exposures.

Support programmes still widely used by euro area banks

The Finnish banking system is interconnected with the financial system of the entire euro area.

The Bank of Finland monitors closely the situation of the banking sectors of the other euro area countries. During the COVID-19 pandemic, particular attention has been paid to the quality of banks’ credit exposures, as the liquidity problems of companies that have suffered from the exceptional conditions may increase banks’ loan losses.

The Bank of Finland also examined in 2021 the ending of interest-only periods granted by euro area banks, and on the other hand, the increasing use of government guarantee programmes. These support measures have helped borrowers during the pandemic, but they may also push credit losses into the future.

The Bank of Finland also analysed developments in international financing conditions. Investors’ risk appetite reflected, on the one hand, the uncertainty as to how long inflation will remain higher than the ECB’s target. On the other hand, corporate profitability was fairly strong despite the pandemic, which supported the stock and corporate bond markets in 2021.