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IMF Country Report No. 23/39

FINLAND

FINANCIAL SYSTEM STABILITY ASSESSMENT

January 2023

This paper on Finland was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on January 3, 2023.

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FINLAND

FINANCIAL SYSTEM STABILITY ASSESSMENT

January 3, 2023

KEY ISSUES

Context: Finland has further improved the regulation and supervision of its financial sector since the 2016 FSAP, in part driven by European legislation and institutions. The size of the banking sector increased significantly in 2018 with the redomicilation of Nordea. Finland weathered the COVID-19 pandemic well relative to other economies, with fiscal support and interventions from the authorities. However, Finland is now navigating a weaker economic outlook given the war in Ukraine and ensuing energy crisis, despite limited direct financial exposures to Russia.

Findings: Risks to financial stability come from a large banking sector, which is highly concentrated and dominated by a few institutions, and is interconnected with other financial systems in the Nordic region. Under a severe but plausible macro-financial scenario, bank solvency falls sharply but remains above regulatory requirements. However, banks remain vulnerable to liquidity shocks due to their reliance on short-term wholesale funding. Household debt levels have increased in recent years to their highest levels, exacerbated further by the pandemic and related policy response. In the Non-bank Financial Intermediation (NBFI) sector, the Pension Insurance Companies (PICs) account for a large share of nonbank assets, have highly correlated portfolios, and exhibit potential procyclical behavior.

Policy Advice: The Finnish authorities should continue to enhance their strong oversight of the financial system. In the context of the improvements made since the 2016 FSAP and the highlighted risks and vulnerabilities, the recommendations focus on: (i) further improvements to governance and resourcing for supervision and regulation; (ii) enhancing the macroprudential toolkit to address household vulnerabilities; (iii) addressing procyclicality in the pension insurance sector; (iv) ensuring the effective operationalization of crisis management arrangements; and (v) strengthening AML/CFT supervision.

Approved By

May Khamis and Oya Celasun

Prepared By

Monetary and Capital Markets Department

• The team was led by Luis Brandao Marques, and included James Knight (Deputy Mission Chief), Mohamed Diaby, Ebru Sonbul Iskender, Fumitaka Nakamura, Apostolos Panagiotopoulos (all MCM); Seyed Reza Yousefi (EUR); Maksym Markevych (LEG); and William Price and Eamonn White (External Experts). Jianhong Liu provided research assistance and Joanna Zaffaroni provided administrative assistance. The FSAP team also collaborated closely with the EUR Article IV Consultation team.

• FSAPs assess the stability of the financial system as a whole and not that of individual institutions. They are intended to help countries identify key sources of systemic risk in the financial sector and implement policies to enhance its resilience to shocks and contagion. Certain categories of risk affecting financial institutions, such as operational or legal risk, or risk related to fraud, are not covered in FSAPs.

• Finland is deemed by the Fund to have a systemically important financial sector according to SM/10/235 (9/16/2010), and the stability assessment under this FSAP is part of bilateral surveillance under Article IV of the Fund's Articles of Agreement.

Contents

• Glossary

• EXECUTIVE SUMMARY

• BACKGROUND

• A. Macrofinancial Developments

• B. Financial Sector Landscape

• C. Macrofinancial Challenges

• SYSTEMIC RISK ASSESSMENT

• A. Systemic Risks and Vulnerabilities

• B. Banking Sector Resilience

• C. Nonbank Financial Institutions

• FINANCIAL SECTOR OVERSIGHT

• A. Bank Oversight

• B. Macroprudential Policy Framework

• C. Climate Risk

• FINANCIAL SAFETY NET AND CRISIS MANAGEMENT

• FINANCIAL INTEGRITY

• AUTHORITIES' VIEWS

• BOX

• 1. Fintech Landscape in Finland

• FIGURES

• 1. Banking Sector

• 2. Household and Corporate Indebtedness

• 3. Cross-Border Exposures and Sources of Funding

• 4. Macroeconomic Scenario

• 5. Solvency Stress Test Results

• 6. Sensitivity Analysis Results

• 7. Liquidity Analysis Results

• 8. Bond Yields and Spreads

• 9. Domestic Interbank Network and Contagion Analysis Results

• 10. Claims of Finnish Banks

• 11. Cross-Border Contagion Analysis Results

• 12. NBFI Assets and Solvency

• 13. PIC Returns and Portfolio Composition

• 14. Vulnerabilities from the Housing Sector and the Configuration of Capital

• TABLES

• 1. FSAP Key Recommendations

• 2. Business Vulnerabilities by Industry

• 3. Financial System Assets: 2016 and 2021

• 4. Selected Economic Indicators

• 5. Financial Soundness Indicators

• 6. Financial Sector Structure

• APPENDICES

• I. Status of Key Recommendations of 2016 FSAP

• II. Risk Assessment Matrix

• III. Stress Testing Matrix

Glossary

Executive Summary

Finland is a small open economy that is significantly exposed to global financial and economic conditions. The economy weathered the COVID-19 pandemic well, thanks to fiscal policy and other interventions. However, Finland is now navigating a weaker economic outlook given the war in Ukraine and ensuing energy crisis.

The strong oversight framework has been further enhanced since the 2016 FSAP, but further important work remains. The authorities have made progress in a range of areas, as reported in subsequent Article IV consultations, in part driven by EU legislation. Legislation for a Systemic Risk Buffer (SyRB) was approved, and efforts to establish a credit register are underway. However, the authorities have not sufficiently expanded the macroprudential toolkit, due to heavy resistance from the financial sector and a lack of political support. Appendix I provides a list of the main 2016 FSAP recommendations and implementation status.

Risks to financial stability emanate from a concentrated banking sector, high household indebtedness, and interconnections in the Nordic region. The Finnish banking sector is large, highly concentrated, and is interconnected with other financial systems in the Nordic region. Household debt levels have increased in recent years to their highest levels, exacerbated by the pandemic. In the non-bank financial intermediation (NBFI) sector, the Pension Insurance Companies (PICs) account for a large share of nonbank assets, with highly correlated portfolios, and have exhibited potential procyclical behavior.

Stress tests indicate that the banking system appears resilient to severe macro-financial shocks but remains vulnerable to liquidity shocks. Under a severe but plausible macro-financial scenario, bank solvency falls sharply but remains above regulatory requirements. However, banks remain vulnerable to liquidity shocks due to their reliance on short-term wholesale funding. Cross-border analysis reveals that the Finnish banking sector is vulnerable to a potential systemic event in Nordic countries due to strong linkages and high exposures.

The banking supervisory framework is sound and operates in the context of EU regulations and supervisory institutions. The authorities have made good progress in the implementation of the recommendations of the 2016 Basel Core Principles (BCP) assessment. Being subject to EU regulations and requirements has helped to enhance financial sector oversight in Finland. However, important issues around strengthening operational independence of the Finland Financial Supervisory Authority (FIN-FSA) and legal protection of FIN-FSA (as well as Financial Stability Authority (FFSA)) staff are pending.

The FSAP recommendations reflect steps to address existing risks and meet new challenges:

• Cross-cutting issues include the need to strengthen the legal protection for officials, staff, and agents of all financial oversight agencies and support the independence of the FIN-FSA. Financial resources available to cover traditional (including NBFI) and emerging risks like Information and Communication Technologies (ICT), cyber, and climate need to be increased across prudential and resolution regimes. Resources for the FIN-FSA and FFSA should be commensurate with their responsibilities. This could be achieved through the reallocation of resources from other areas of work, gains in efficiency including using suptech, or through a larger financial envelope via increased fees and/or a greater contribution from the public sector. The FFSA should also ensure that its budget is sufficient to enable the rapid procurement of the full range of external advisory support to carry out its statutory function.

• Banking supervision could be further improved by conducting further analysis on banks' IFRS-9 implementation and including rules on the appointment of a sufficient number of independent directors to boards of directors and including independency criteria in legislation.

• The macroprudential toolkit should be expanded and the systemic risk monitoring framework strengthened to ensure the effective conduct of macroprudential policy. Macroprudential policy tools, including caps on debt-to-income (DTI) or debt-service-to-income (DSTI) ratios should be included in the toolkit. The authorities should enhance their systemic risk monitoring framework. The authorities should also consider introducing a positive rate for the Counter-Cyclical Capital Buffer (CCyB) in a standard risk environment, which requires a legislative amendment.

• Solvency rules for PICs should be further changed to avoid a short-term focus and fully mitigate procyclical behavior, and thus enhance financial stability. The FIN-FSA and the Bank of Finland (BoF) should enhance the public disclosure of analysis and assessment of macroprudential risks in the NBFI sector.

• Resolution and crisis management should be supported by greater coordination of authorities' preparation and management of future crises. The FFSA should publish a framework for scoring less significant institution (LSI) resolvability (or implement a Single Resolution Board framework for such purposes) and a bail-in mechanic that addresses key policy choices. The BoF should ensure that it has fully operational liquidity facilities for resolution purposes and test these lending arrangements with its counterparties. The Deposit Guarantee Fund (DGF) should have sufficient funds to ensure its financial autonomy and minimize its dependency on borrowing from banks to payout.

• Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) policy. Efforts are needed to strengthen the effectiveness of AML/CFT supervision.

The FSAP recommends targeted measures outlined in Table 1.

^{Table 1.}

Finland: FSAP Key Recommendations

¹Timing: C = Continuous; I = Immediate (within one year); NT = Near Term (within 1-3 years); MT = Medium Term (within 3-5 years).

^{Table 1.}

Finland: FSAP Key Recommendations

	Recommendation	Addressee	Timing1
Oversight—Cross cutting
1	Strengthen the legal and operational framework for legal protection of officials, staff, and agents of all financial oversight agencies.	MOF	NT
2	Secure FIN-FSA's independence by ensuring that: (i) the law is amended to ensure that future Board members are not officials of Ministries; (ii) a statement of the reasons for the dismissal of Director General is clearly laid down in the law and publicly disclosed if a dismissal should ever take place; and (iii) Board members have diverse backgrounds and experience in FIN-FSA's purview.	MOF	NT
3	Increase the resources available to the FIN-FSA, FFSA and other financial oversight agencies so that they are commensurate with their responsibilities and allow them to cover both traditional and emerging risks like ICT, cyber, and climate.	BoF, FFSA and MOF	NT
Macroprudential Policy
4	Consider providing the FIN-FSA Board with hard powers to issue regulations on macroprudential policy, including the adoption of new instruments; and/or semi-hard powers to issue recommendations on a comply or explain basis.	MOF	MT
5	Add DTI and DSTI limits to the macroprudential policy toolkit; and introduce a positive rate of CCyB in the standard risk environment.	MOF	MT
6	Enhance the systemic risk monitoring by strengthening the disaggregated data analysis, corporate sector vulnerability analysis and addressing existing data gaps.	BoF and FIN-FSA	MT
Systemic Risk Assessment
7	Enhance liquidity buffers to cover a predetermined threshold of wholesale funding outflows over a five-day horizon.	FIN-FSA	NT
8	Lead an effort to conduct a Nordic-wide stress test coordinated exercise.	FIN-FSA, and BoF	MT
Banking Regulation and Supervision
9	Conduct further analysis on banks' IFRS-9 implementation, more specifically regarding staging of exposures and functioning of expected credit loss models.	FIN-FSA	NT
10	Include rules on the appointment of a sufficient number of independent directors (supervisory board members) and independency criteria in the legislation.	MOF, FIN-FSA	NT
Nonbank Financial Institutions
11	Amend PIC solvency regulations to remove remaining procyclical effects and develop new short-term liquidity rules.	MoSAH FIN-FSA	NT
12	Enhance the public disclosure of analysis and assessment of macroprudential risks in the NBFI sector.	BoF, FIN-FSA	NT
Crisis Management
13	Publish a policy on bail-in and transfer mechanics that addresses policy choices on valuation, issuance of new instruments and change in control requirements.	FFSA	NT
14	Ensure that emergency liquidity assistance processes, procedures and operational capabilities are sufficient to support a rapid provision of temporary collateralized liquidity for FIs in resolution, tested internally and with external counterparties annually.	BoF	NT, C
15	Centralize cross-authority crisis cooperation and coordination in the Crisis Management Cooperation Group.	FFSA, FIN-FSA, BoF, MoF, MoSAH	I, C
Financial Integrity
16	Enhance AML/CFT supervision by improving the risk-based approach and tools for AML/CFT sectoral and institutional risk assessments, with a focus on risks from cross-border and non-resident transactions.	FIN-FSA	I

¹Timing: C = Continuous; I = Immediate (within one year); NT = Near Term (within 1-3 years); MT = Medium Term (within 3-5 years).

View Table

^{Table 1.}

Finland: FSAP Key Recommendations

	Recommendation	Addressee	Timing1
Oversight—Cross cutting
1	Strengthen the legal and operational framework for legal protection of officials, staff, and agents of all financial oversight agencies.	MOF	NT
2	Secure FIN-FSA's independence by ensuring that: (i) the law is amended to ensure that future Board members are not officials of Ministries; (ii) a statement of the reasons for the dismissal of Director General is clearly laid down in the law and publicly disclosed if a dismissal should ever take place; and (iii) Board members have diverse backgrounds and experience in FIN-FSA's purview.	MOF	NT
3	Increase the resources available to the FIN-FSA, FFSA and other financial oversight agencies so that they are commensurate with their responsibilities and allow them to cover both traditional and emerging risks like ICT, cyber, and climate.	BoF, FFSA and MOF	NT
Macroprudential Policy
4	Consider providing the FIN-FSA Board with hard powers to issue regulations on macroprudential policy, including the adoption of new instruments; and/or semi-hard powers to issue recommendations on a comply or explain basis.	MOF	MT
5	Add DTI and DSTI limits to the macroprudential policy toolkit; and introduce a positive rate of CCyB in the standard risk environment.	MOF	MT
6	Enhance the systemic risk monitoring by strengthening the disaggregated data analysis, corporate sector vulnerability analysis and addressing existing data gaps.	BoF and FIN-FSA	MT
Systemic Risk Assessment
7	Enhance liquidity buffers to cover a predetermined threshold of wholesale funding outflows over a five-day horizon.	FIN-FSA	NT
8	Lead an effort to conduct a Nordic-wide stress test coordinated exercise.	FIN-FSA, and BoF	MT
Banking Regulation and Supervision
9	Conduct further analysis on banks' IFRS-9 implementation, more specifically regarding staging of exposures and functioning of expected credit loss models.	FIN-FSA	NT
10	Include rules on the appointment of a sufficient number of independent directors (supervisory board members) and independency criteria in the legislation.	MOF, FIN-FSA	NT
Nonbank Financial Institutions
11	Amend PIC solvency regulations to remove remaining procyclical effects and develop new short-term liquidity rules.	MoSAH FIN-FSA	NT
12	Enhance the public disclosure of analysis and assessment of macroprudential risks in the NBFI sector.	BoF, FIN-FSA	NT
Crisis Management
13	Publish a policy on bail-in and transfer mechanics that addresses policy choices on valuation, issuance of new instruments and change in control requirements.	FFSA	NT
14	Ensure that emergency liquidity assistance processes, procedures and operational capabilities are sufficient to support a rapid provision of temporary collateralized liquidity for FIs in resolution, tested internally and with external counterparties annually.	BoF	NT, C
15	Centralize cross-authority crisis cooperation and coordination in the Crisis Management Cooperation Group.	FFSA, FIN-FSA, BoF, MoF, MoSAH	I, C
Financial Integrity
16	Enhance AML/CFT supervision by improving the risk-based approach and tools for AML/CFT sectoral and institutional risk assessments, with a focus on risks from cross-border and non-resident transactions.	FIN-FSA	I

¹Timing: C = Continuous; I = Immediate (within one year); NT = Near Term (within 1-3 years); MT = Medium Term (within 3-5 years).