Bank of Finland Bulletin 2/2014: Financial stabilityPentti Hakkarainen, Deputy Governor

15.5.2014

Themes of the stability report

• Owing to the weak outlook for the real economy, particular attention needs to be devoted to the vulnerabilities of the domestic financial system.

• Risks can be created by: housing price developments and households’ considerable debt levels, effects of low interest rates and transmission of bank lending.

• As demonstrated by the financial crisis, Finland also needs internationally comparable instruments for prevention of systemic risks.

• Banking union marks an important step forward. Supervision and resolution should be on the same cross-border level as the actual operations of financial institutions.

15.5.2014 2

315.5.2014

Risks related to economic and credit cycles

415.5.2014

-200

0

200

400

600

800

2007 2008 2009 2010 2011 2012 2013 2014

Basis points

Public sector*, peripheral countries**Public sector*, Countries with good credit ratingsFinancial institutions, peripheral countries**Financial institutions, countries with good credit ratings

* Public-sector bonds refer to bonds issued by local government and centralgovernment-guaranteed bonds.** Peripheral countries: Italy, Spain, Greece, Ireland and Portugal.Sources: Bloomberg and BofA Merrill Lynch.

Risk premia on bonds issued by financial institutions andpublic-sector entities*

Improved access to finance supports euro area’s gradual recovery from the crisis

515.5.2014

0

100

200

300

400

500

0

5

10

15

20

25

1998 2001 2004 2007 2010 2013

Numer of issues (right-hand scale) Risk premium

%

Source: Bloomberg.

Number

Issues of bonds by high-risk non-financial corporations and risk premia on yields

Increased risk appetite may distort prices on securities markets

6

Share prices on the increase

15.5.2014

60

100

140

180

220

2009 2010 2011 2012 2013 2014

S & P 500 index Tokyo, Nikkei 225 index Total euro area: Dow Jones Euro Stoxx (Broad) index MSCI emerging markets index

Beginning of period = 100

Source: Bloomberg.

Stock indices of major countries

Risks transmitted from abroad to Finland

• The development of the international economy and financial markets has a great impact on the prospects and risks for the Finnish economy and financial system.

Risks of key concern for Finland: Emergence of renewed instability on international financial markets. Long-sustained low level of interest rates and excessive rise in

asset prices. Impact of geopolitical tensions on the Finnish economic outlook.

15.5.2014 7

8

Domestic economy, non-financial corporations, households, public finances

15.5.2014

Makrotalous

Asuntojen hinnat

VelkaantuneisuusRiskipreemiot

Pankkien kestävyys

IV/2009 I/2012 III/2012

Suomen rahoitusjärjestelmän vakauskartta

Lähteet: NASDAQ OMX Helsinki, pankit, Tilastokeskus ja Suomen Pankki.

Makrotalous

Asuntojen hinnat

VelkaantuneisuusRiskipreemiot

Pankkien kestävyys

IV/2009 I/2012 III/2012

Suomen rahoitusjärjestelmän vakauskartta

Lähteet: NASDAQ OMX Helsinki, pankit, Tilastokeskus ja Suomen Pankki.

June 2012 June 2013 May 2014

Makrotalous

Asuntojen hinnat

VelkaantuneisuusRiskipreemiot

Pankkien kestävyys

IV/2009 I/2012 III/2012

Suomen rahoitusjärjestelmän vakauskartta

Lähteet: NASDAQ OMX Helsinki, pankit, Tilastokeskus ja Suomen Pankki.

The outer values reflect higher systemic risks.Sources: NASDAQ OMX Helsinki, banks, Statistics Finland and Bank of Finland.

9

Housingprices

Real economy

Banks’viability

IndebtednessRisk premia

Indebtedness and development of the real economy pose the main risks to the Finnish financial system

15.5.2014

1015.5.2014

-20

-10

0

10

20

30

0

2

4

6

8

10

2005 2007 2009 2011 2013

1 Average interest rate on corporate loan stock* (left-hand scale) 2 Average interest rate on new corporate loans* (left-hand scale) 3 Corporate loans, annual growth rate** (right-hand scale)

1

2

3

%

* Includes housing corporations. ** Excludes housing corporations.Source: Bank of Finland.

Average interest rates on MFI corporate loans and annual growth rate in Finland

%

Growth rate of MFI corporate loans has remained subdued

11

Interest rates on corporate loan stock in euro area countries

15.5.2014

0

1

2

3

4

5

6

7

2009 2010 2011 2012 2013 2014

Finland Germany France Italy Spain Euro area

%

Sources: European Central Bank and Bank of Finland calculations.

1215.5.2014

0

20

40

60

80

100

2009 2010 2011 2012 2013 2014

Got everything Got part of itRefused to withdraw because cost too high Application rejectedDon't know

Source: European central bank.

%

* October–March.** April–September.

* *** ** * **

Access to finance has remained good in the corporate sector in Finland

1315.5.2014

Bankruptcies increasing slightly, but still at a moderate level

0

2

4

6

8

0

2

4

6

8

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Bankruptcy filings for non-financial corportaions, 12-month moving sum (left-hand scale)

Banks' non-performing assets* (right-hand scale)

Number, 1,000

* Assets due and unpaid for at least 90 days.Sources: Statistics Finland, Financial Supervisory Authority and Bank of Finland calculations.

Bankruptices and non-performing assets in Finland

EUR billion

1415.5.2014

0

1

2

3

4

5

6

7

0

20

40

60

80

100

120

140

2000 2002 2004 2006 2008 2010 2012

Other loans (left-hand scale)Housing corporation loans* (left-hand scale)Housing loans (left-hand scale)Interest expenditure (right-hand scale)

% of disposable income

* Statistics Finland’s estimate of the loan stock of household-owned housing corporations.Sources: Statistics Finland and Bank of Finland calculations.

Household indebtedness and interest burden in Finland

% of disposable income

Household indebtedness continued to grow but at a slower pace

1515.5.2014

Half of household debts held by a tenth of households

0

40

80

120

160

200

240

0

10

20

30

40

50

60

Households with no debt Households with debtratio of over 0 % and

up to 300 %

Households with debtratio of over 300 %

Share of households (left-hand scale)Share of total household debt (left-hand scale)Average debt per household (right-hand scale)

%

* Debt ratio = household debt, % of disposable monteary income in 2012.Sources: Statistics Finland and Bank of Finland calculations.

Households and their debt by debt ratio*

EUR, thousands

1615.5.2014

0

5

10

15

20

2005 2007 2009 2011 2013

Total loans Housing loans

%

* Finnish households' euro-denominated loans from MFIs operating in Finland, excluding household-owned housing corporation loans.Source: Bank of Finland.

Annual change in household loan stock* in Finland

Growth rate of housing loans has decelerated

1715.5.2014

80

100

120

140

160

2000 2003 2006 2009 2012

Whole country Greater Helsinki area Rest of Finland

Index, 2000 = 100

Nominal housing price indices are converted into real indices, using the consumer price indexfor the whole country.Source: Statistics Finland.

Real housing prices in Finland

Real housing prices have declined, regional differences in price developments

1815.5.2014

Financial system risk resilience and structural risks

1915.5.2014

0

5

10

15

20

25

0

5

10

15

20

25

2007 2008 2009 2010 2011 2012 2013

Loss buffer* (left-hand scaleMinimum requirement for own funds (left-hand scale)Capital adequacy ratio (Tier 1 and Tier 2) (right-hand scale)Common Equity Tier 1 ratio (CET1) (right-hand scale)

EUR bn

* Own funds surplus = own funds − minimum requirement for own funds.Source: Financial Supervisory Authority.

Own funds and capital adequacy in the Finnish banking sector

%

Finnish banking sector’s risk resilience has remained good

2015.5.2014

Banking sector performance unchanged and loan losses small

-8

-4

0

4

8

2007 2008 2009 2010 2011 2012 2013

Net interest income Net fee incomeNet income from trading and investment Other incomeExpenses and depreciations Net impairment lossesPre-tax profit

EUR bn

Source: Financial Supervisory Authority.

Finnish banking sector performance

2115.5.2014

-2

0

2

4

6

1999 2001 2003 2005 2007 2009 2011 2013

Overall margin (average interest rate on loan stock - average interest rate on deposit stock)3-month Euribor

%

Finnish MFI loans to and deposits from the public.Sources: Reuters and Bank of Finland.

Overall margin and 3-month Euribor

Low interest rates and slower growth of lending stock strain profitability

2215.5.2014

Dependency on international wholesale funding increases vulnerability

0

50

100

150

200

2006 2008 2010 2012 2014

Issues of long-term debt securitiesIssues of short-term debt securitiesLoans to households and non-financial corporationsDeposits from households and non-financial corporationsStructural financial deficit (loan stock - deposit stock)

EUR bn

Deposit banks, mortgage banks and other credit institutions in the same group.Source: Bank of Finland.

Finnish banking sector’s dependency on wholesale funding

Banking sector sensitive to contagion

• Finnish banking sector’s degree of concentration among the highest in the EU.

• Strong interconnectedness within the Nordic banking system. Large amount of assets in the Nordic countries, only small amount in the higher-risk countries.

• Significant share of the Finnish banking sector in the ownership of Nordic parent banks.

• Domestic banks’ foreign assets and liabilities have increased in the 2000s.

15.5.2014 23

24

Insurance sector has maintained its solvency

15.5.2014

• Insurance sector profitability and solvency have remained good, but considerable differences between companies can be observed.

• Insurance companies have been able to adjust their business models in the low interest rate environment.

• Unexpected shocks in the investment market pose the main risk to profitability and solvency.

25

Infrastructure has operated reliably

• A reliable infrastructure that functions under all circumstances is a key part of a stable financial system – International cooperative oversight plays an important role

• Fragmentation of functions can endanger continuity – National contingency arrangements important

• Finland migrated to SEPA on schedule, development continues – New cooperation groups have been established: the Euro

Retail Payments Board (ERPB) in Europe and the Payments Council in Finland

15.5.2014

2615.5.2014

Measures to ensure financial stability

27

The macroprudential tools to be introduced in Finland

• Countercyclical capital buffer requirement: 2015

• Binding maximum loan-to-value (LTV) ratio for housing loand (loan-to-value cap): 7/2016

• Minimum risk weights for housing loans: 2015

• Additional capital requirement for domestic systemically important credit institutions (O-SII requirement): 2016

15.5.2014

28

…. should be supplemented

• Use of the systemic risk buffer should also be made possible in Finland – Additional capital requirement permitted by the Capital

Requirements Directive if the national banking sector is structurally vulnerable

– There should not be big differences in regulation and supervision in an integrated banking market

– Nearly all EU countries will incorporate the requirement in their legislation

• An internationally comparable set of instruments is necessary; use of the instruments to be determined separately.

15.5.2014

29

National additional capital requirements for systemically important credit institutions in the Nordic countries, maximum

requirement

0

1

2

3

4

5

6

Sweden Norway Denmark Finland

National additional capital requirements for systemically important credit institutions in the Nordic countries, maximum amount

%

Source: National central banks.

15.5.2014

Banking union about to start

• The two key elements of banking union – single supervision of banks and single resolution – are about to start.

• The resolution mechanism and bail-in remove/reduce the costs of banking crises to taxpayers.

• Also in Finland, resolution legislation and the related powers for authorities must be implemented promptly in all respects.

15.5.2014 30

31

Single Resolution Mechanism

15.5.2014

3215.5.2014

Thank you!