## cr1703 ## Source details **Canonical URL:** [cr1703](https://www.imf.org/-/media/files/publications/cr/2017/cr1703.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr1703.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr1703.pdf.json) --- ### SSM transition and supervisory responsibilities - Introduction of the Single Supervisory Mechanism (SSM) in November 2014 significantly changed FIN-FSA’s prudential supervision role. - ECB prudential supervisory function took over responsibility for the largest banks in Finland, now holding more than 90 percent of the banking sector’s assets. - Three banks were designated as significant institutions (SIs) since the beginning and one more joined the group of Finnish SIs in 2016; FIN-FSA retained responsibility for supervising the nine remaining Finnish banks deemed to be less significant (LSIs). - Under the SSM staffing model, ECB leads supervision teams but most supervisors are expected to come from the national competent authorities (NCAs), increasing resource demands on NCAs. - ECB has adopted a more intense and intrusive approach to banking supervision than typically followed in the Nordic area; these higher standards, initially focused on SIs, are being gradually adopted for LSIs. ### Nordea transformation and cross-border supervisory coordination - Planned conversion of Nordea Bank Finland (NBF) to a branch of Sweden’s Nordea Bank AB at the beginning of 2017 will result in Nordea’s branch, plus a standalone mortgage credit subsidiary, becoming the second largest bank in Finland. - Nordea Bank Finland had assets at year-end 2015 of €301.6 billion, almost threefold the next largest Finnish bank, OP Group. - Near-term action: - Consistent with CRD, Finland and the ECB should seek an appropriate supervisory memorandum of understanding with Sweden covering large significant branches to provide greater access to information and enhanced powers regarding supervisory engagement with the branches and parent banks. - Medium-term consideration: - For branches systemically important in a host country, future revisions of CRD IV should consider providing enhanced supervisory powers for host country supervisors, in close coordination with home supervisors, to promote resilience and resolvability of branches. ### Enforcement and sanctioning framework - SSM enforcement and sanctioning framework combines powers assigned to ECB or NCAs; NCAs’ powers are not fully harmonized. - Where ECB lacks direct powers, it can request or instruct NCAs to act based on available national powers. - This complex arrangement has not yet been fully tested in Finland. ### SREP, legal powers, and decision-making on capital - SSM SREP is well structured with emphasis on analysis of banks’ risks and decisions on capital and liquidity levels. - Finnish legislation grants FIN-FSA powers not fully aligned with CRD, limiting FIN-FSA’s ability to impose supervisory measures for deficiencies in internal governance or to require adjustment of provisions for prudential purposes. - SREC/SREP process elements: - Four SREP elements: (a) business model and profitability; (b) internal governance and risk management; (c) risk-by-risk assessment of risks to capital; (d) risk-by-risk assessment of risks to liquidity and funding. - SREP assessments performed at least annually and underpin supervisory actions (capital decision, liquidity decision, other measures). - Communication and disclosure: - JSTs encouraged to meet bank management to present SREP conclusions; SREP decision communicated via a legally binding SREP letter with motivations. - Recommendation to consider disclosure of total capital requirements to inform maximum distributable amount decisions; move toward capitalization indices (ratio of own funds to whole capital requirements) is suggested. ### Internal models, IRB risk weights, and TRIM - IRB model landscape: - Five banking groups with approved IRB models in Finland; first IRB models approved in 2007. - Risk-weight metrics: - Credit risk density dropped from 34.7 percent at the end of 2008 to 18.6 percent at the end of 2015. - Risk weights applied to mortgage exposures by Finnish banks using IRB models are, on average, the lowest in Europe. - FIN-FSA Board decision: - Introduced a floor of 10 percent for the average risk weight on housing loans of IRB banks; this minimum level would come into force on 1 July 2017 at the latest. - TRIM: - ECB ‘TRIM’ project planning ongoing and execution expected "in the next two years." - TRIM aims to address lack of comparability between models across the SSM and situations where banks may have reduced conservatism to “optimize” RWAs. - Authorities need organizational/procedural solutions to ensure TRIM results can be maintained post-project through sustainable ongoing model monitoring. - Ongoing Model Monitoring (OMM) concerns: - Internal review (December 2015) found "almost one-third of the respondents were very dissatisfied with respect to the adequacy of JSTs to perform on-going monitoring of models." - Resource constraints and limited experience can materially affect OMM implementation. ### Liquidity, funding risks, and covered bonds cross-holdings - System metrics and exposures: - Total banking system assets are equivalent to 230 percent of GDP. - Two-thirds of banking assets are in foreign-owned banks. - Loan-to-deposit ratio is 124 percent. - Wholesale funding accounts for more than half of banks’ funding. - Principal wholesale instruments and shares of total funding: deposits from credit institutions (20 percent), covered bonds (10 percent), senior unsecured bonds (10 percent), repo transactions (8 percent), and commercial paper/time deposits (6 percent). - A majority of wholesale funding is provided by foreign financial institutions; share of foreign counterparts in wholesale funding is 78 percent for the whole system. - Liquidity framework improvements and vulnerabilities: - Regulatory and supervisory framework for liquidity and funding risk has improved since the 2010 FSAP, but vulnerabilities persist. - EU implementation of the LCR is in force since October 2015 with phase-in from 70 percent as of January 2016 to 100 percent from January 2018; third quarter 2016 reporting changed from quarterly to monthly. - EU deviations from BCBS widen HQLA eligibility, notably more generous inclusion of covered bonds, non‑externally rated covered bonds in Level 2B, and inclusion of certain PSE claims in Level 1. - Covered bonds concentration and contagion risk: - Sizable holdings of covered bonds average around 30 percent of Finnish banks’ liquid assets. - Instances of excessive concentration include exposures to a restricted range of issuers and, in certain cases, a single issuer (even above 95 percent). - High level of covered bonds cross-holding in the Nordic area could be a source of contagion if a major correction in house prices undermines confidence. - Policy consideration: imposition of concentration limits on covered bonds should be considered. - Asset encumbrance: - Intense issuance of covered bonds represents potential significant asset encumbrance; a common methodology should be created to establish alarm thresholds and supervisory actions. ### Credit risk, NPLs, coverage, and capital adequacy - NPLs and coverage: - Average NPL ratio is 1.57 percent of total loans (1.62 percent for SIs, 1.15 percent for LSIs). - Coverage ratios are around 30 percent. - Low coverage partly justified by Finnish specifics: foreclosure rarely activated; banks prefer voluntary sales. - Capital adequacy: - Overall capital adequacy ratio of the banking sector (excluding Municipality Finance) increased to 23.1 percent at the end of 2015 from 17.3 percent at the end of 2014. - Common equity tier 1 (CET1) ratio was 21.0 percent at the end of 2015 (15.8 percent at the end of 2014). - Improvements due to retained earnings, injections of new capital, and more extensive use of internal models reducing RWAs. - Monitoring data gaps: - Supervision lacks regular availability of individual loan file data; Finland has no central credit register and the credit bureau is of ‘negative’ nature. - New data collection starting Q3 2016 will require banks to report information on new housing loans and the relative collateral; granular data on existing loans and collateral still lacking. - Recommendation to implement regular data collection of individual loan files (e.g., loan registry system). ### FIN-FSA mandate, governance, and operational arrangements - FIN-FSA responsibilities: - Supervises banks, insurance and pension companies, investment firms, fund management companies and the Helsinki Stock Exchange. - FIN-FSA is formally under the administration of the Bank of Finland; supervisory decision-making is independent. - FIN-FSA Board composition and governance observations: - Board composed of five members appointed by Parliamentary Supervisory Council for a three-year term; chaired by the Deputy Governor of the Bank of Finland; includes nominees from the Ministry of Finance, the Ministry of Social Affairs and Health, and the Bank of Finland; two independent members chosen by the Parliamentary Supervisory Council. - Observed governance issue: Board composition with government officials creates an appearance of lack of independence; appointing future Board members from outside government would reduce perceived risks. - Internal organization and staffing: - 2015 staffing approximately 186 full-time equivalent (FTEs); approximately 60 FTEs devoted to banking supervision; administrative support equivalent to another 21 FTEs for a total of 81 FTEs supporting banking supervision. - FIN-FSA assigned approximately 33 FTEs to supervisory tasks (off-site and on-site) and 35 FTEs to other SSM-related tasks; of supervisory FTEs, 13 FTEs were assigned to JSTs supervising Finnish SIs. - Those 13 FTEs comprised 33 different individuals with allocations ranging between 10 and 90 percent, average around 40 percent; staff allocations below 50 percent jeopardize productivity. - Managers have on average 11 years of relevant experience; staff have an average of 12 years of supervisory experience. - Turnover among junior staff (less than 3 years of experience) was 22 percent in 2015. - Staffing levels roughly flat since 2010 and expected to remain the same over the next several years despite increased supervisory demands. - Recommendation: - Gradually increase number of supervisory staff to accommodate SSM demands on FIN-FSA staff for JSTs and inspection teams and the more intense supervision expected for LSIs. - Strengthen legal protection of FIN-FSA officials and staff; determine Finnish equivalent of “good faith” and enshrine in legislation and operational arrangements. ### Supervisory approach — SIs and LSIs, on-site inspections - SIs: - Each SI supervised by a Joint Supervisory Team (JST) led by an ECB coordinator; JSTs undertake yearly SREPs and day-to-day supervision. - SREP uses data (FINREP, COREP), automated anchoring from Risk Assessment System (RAS), and supervisory judgment. - On-site inspections in Finland (2015): eight inspections on Finnish SIs; topics included asset classification and provisioning, governance, operational risk, liquidity risk, and IT issues; average mission duration trending toward SSM standard (~five weeks); missions typically staffed with four to five persons. - LSIs: - LSIs remain direct responsibility of FIN-FSA under ECB oversight; SREP for LSIs converging to SSM approach. - SREP frequency: annual for high priority LSIs; every 2 or 3 years for other LSIs. - 2015 on-site activity: 23 on-site inspections on LSIs. - FIN-FSA uses annual off-site planning and bi-annual on-site planning; aims to leverage on-site time to interact with middle management and observe IT systems. - Credit file reviews performed during on-site inspections often use non-statistical samples limiting extrapolation; ECB updating SSM Manual to provide common credit risk on-site methodology. - Standardization risk: - Standardization of supervisory methods necessary for comparability but may shift toward excessive compliance-based techniques and distract from risk-focused tasks. - Industry feedback: - Overall improvement in supervision level; communication between supervisors and banks can improve (e.g., better explanation of purpose and final use of data collections). ### Rating systems, corrective measures, and supervisory tools - Two rating systems: - Automatic quarterly indicator-based rating focused on capital adequacy, profitability, credit risk, liquidity, and IRRBB. - Comprehensive SREP rating combining individual risk indicators and other information. - Automatic rating outcomes (four possible): - normal supervision; - enhanced supervision; - early corrective actions; - special corrective actions. - Enforcement and sanctioning: - For SIs, ECB has direct pecuniary sanction powers for breaches of ECB decisions or directly applicable EU law; non-pecuniary sanctions and sanctions on natural persons are to be imposed by NCAs upon ECB request. - For LSIs, sanctioning power rests with the NCA. - Finnish administrative fines: legal person no less than EUR 5,000 and no more than EUR 100,000; natural person no less than EUR 500 and no more than EUR 10,000. - Penalty payments caps: legal person no more than 10 percent of turnover of preceding year and no more than EUR 10 million; natural person no more than 10 percent of income but no more than EUR 100,000; for offences under Act on Credit Institutions chapter 20 section 1, natural person penalty payment no more than EUR 5 million. - Time limits: administrative fines/public warnings must be imposed within five years; penalty payments must be proposed within ten years of act/omission, or five years for continued acts once terminated. ### LCR implementation, deviations from Basel, and supervisory review of LCR/ILAAP - FIN-FSA thematic review on LCR and ILAAP initiated May 2016 to verify compliance and assess quality of liquidity management; follow-up could include supervisory visits, inspections, and feed into SREP. - EU LCR implementation: - In force in the EU since October 2015; phase-in from 70 percent as of January 2016 to 100 percent from January 2018. - Commission delegated regulation (EU) 2015/61 supplements CRR on LCR. - Key EU deviations widen HQLA eligibility (e.g., covered bonds treated more generously than Basel). - EBA analysis: deviations lead to increase in LCR of 13.9 percentage points for sample banks and reduced number of banks failing 100 percent LCR from 74 to 17. - FIN-FSA actions for LSIs: - FIN-FSA standard "Management of Liquidity Risk" (4.4d) applied to LSIs; liquidity risks monitored annually via SREP and a quarterly monitoring report. - Ongoing FIN-FSA project developing stress tests/tools: LCR sensitivity tool, survival horizon tool and NSRF sensitivity tool. ### Key recommendations — Main Recommendations - 1. Ensure that the Finnish legislation grants the FIN-FSA all the powers it needs according to the CRD to impose decisions on capital and liquidity requirements and supervisory measures on LSIs. (MoF) NT - 2. Increase the number of supervisory staff to accommodate the SSM demands of FSA staff on JSTs and inspection teams, and in response to the more intense supervision expected for LSIs. (FSA) MT - 3. Strengthen the legal protection of the FSA officials and staff. (MoF, BoF) NT - 4. Seek a supervisory memorandum of understanding with the Swedish authorities covering large significant foreign branches, providing for enhanced access to information and supervisory engagement with the branches and parent banks. (ECB, FSA) NT - 5. Raise with the European Commission the question of how the CRD might be amended to retain the original objective of encouraging the free flow of financial services within the EU while, at the same time, providing host supervisors with additional authority over systemically-important institutions, in close collaboration with the home supervisor. (MoF, ECB) MT - 6. Proceed with the announced comprehensive review of banks’ internal models and devise, for the future, a sustainable form of ongoing model monitoring to prevent banks from reducing again the degree of conservatism in their models. (ECB, FSA) MT - 7. Analyze, within the SSM and in collaboration with the other supervisors in the EU, the risks possibly stemming from the crossholding of bonds, in particular covered bonds and consider imposing concentration limits. (ECB, FSA) MT - 8. Implement a regular data collection of individual loan files (e.g., a loan registry system) to better support the analysis of credit risk. (FSA) MT ### Key recommendations — Other Recommendations (selected) - 9. Reinforce FIN-FSA independence, by ensuring future Board members have diverse background and experience and are not concurrently serving in politically appointed positions. (MoF) MT - 10. Continue to closely monitor banks’ loan portfolios to verify the evolution of renegotiated loans. (ECB, FSA) NT - 11. Update the on-site methodology to ensure that the samples of loan files analyzed during inspections are selected according to statistically robust criteria. (ECB) MT - 12. Establish a regular program to directly verify the correct classification and valuation of fair‑valued positions and any consequent need for additional valuation adjustments in banks with consistent amounts of Level 2 and 3 assets. (ECB, FSA) MT - 13. Closely monitor the impact on the bank’s loss absorbency of the ‘Danish compromise’ waiver (allowing banks in financial conglomerates not to deduct insurance participations). (ECB) NT - 14. Analyze the impact of the proposed law restraining municipalities tax-raising powers on Municipality Finance and the other banks. (ECB, FSA) NT - 15. Ensure that the need for consistency of the supervisory methods and techniques does not distract energy, time and resources from more risk‑focused tasks (ECB) NT - 16. Improve the communication with the banks, including with respect to the outcome of the SREP. (ECB, FSA) MT - 17. Improve the external communication strategy to further highlight the specificities of the SSM, especially as regards the difference between SIs and LSIs. (ECB, FSA) MT NT = Near Term (within 6 months / 1 year); MT = Medium Term (within 2-3 years) *Source: IMF staff report (2016 FSAP mission) — EXECUTIVE SUMMARY* ### EXECUTIVE SUMMARY __________________________________________________________________________ 5 ### EXECUTIVE SUMMARY ### SSM transition and supervisory responsibilities - The introduction of the Single Supervisory Mechanism (SSM) in November 2014 significantly changed the FIN-FSA’s responsibility for prudential supervision of the banking sector. - The ECB prudential supervisory function took over responsibility for the largest banks in Finland, now holding more than 90 percent of the banking sector’s assets. - Three banks were designated as significant institutions (SIs) since the beginning and one more joined the group of Finnish SIs in 2016; the Finnish FSA (FIN-FSA) retained responsibility for supervising the nine remaining Finnish banks deemed to be less significant (LSIs). - Under the SSM staffing model, while the ECB leads supervision teams, most supervisors are expected to come from the national competent authorities (NCAs), increasing rather than reducing resource demands on NCAs. - The ECB has adopted a more intense and intrusive approach to banking supervision than that typically followed in the Nordic area; these higher standards, initially focused on SIs, are being gradually adopted for LSIs as well. ### Nordea transformation and cross-border supervisory coordination - The planned conversion of Nordea Bank Finland (NBF) to a branch of Sweden’s Nordea Bank AB at the beginning of 2017 will result in Nordea’s branch, along with a standalone mortgage credit subsidiary, becoming the second largest bank in Finland. - Near-term action: consistent with CRD, Finland and the ECB should seek an appropriate supervisory memorandum of understanding with Sweden covering large significant branches to provide greater access to information and enhanced powers regarding supervisory engagement with the branches and parent banks. - Medium-term consideration: for branches systemically important in a host country, any future revisions of CRD IV should consider providing enhanced supervisory powers for host country supervisors, in close coordination with home supervisors, to promote resilience and resolvability of branches. ### Enforcement and sanctioning framework - The SSM enforcement and sanctioning framework combines powers assigned either to the ECB or the NCAs, with latter powers not being fully harmonized. - Where the ECB lacks direct powers to impose an enforcement measure or sanction, it can request or instruct NCAs to act based on their available powers. - This complex arrangement has not yet been fully tested in Finland. ### Supervisory Review and Evaluation Process (SREP) and legal powers - The SSM SREP is well structured and gives adequate emphasis to analysis of banks’ risks and decisions on capital and liquidity levels. - Finnish legislation grants the FIN-FSA powers that are not fully aligned with those required by the CRD, limiting FIN-FSA’s ability to impose supervisory measures for deficiencies in internal governance or to require adjustment of provisions for prudential purposes. ### Internal models, IRB risk weights, and TRIM - The FIN-FSA Board has proposed introducing a floor on risk weights of mortgage exposures in banks’ IRB models. - Risk weights applied to mortgage exposures by Finnish banks using IRB models are, on average, the lowest in Europe. - The SSM Targeted Review of Internal Models (TRIM) project, planning ongoing and execution expected in the next two years, represents an important opportunity to: - address lack of comparability between models across the SSM, - address situations where banks may have reduced conservatism in models to “optimize” RWAs. - Authorities need to devise organizational and/or procedural solutions to ensure TRIM results can be maintained post-project through sustainable ongoing model monitoring. ### Liquidity and funding risks, covered bonds cross-holdings - The regulatory and supervisory framework for liquidity and funding risk has improved since the 2010 FSAP, but vulnerabilities persist. - Finnish banks continue to rely extensively on wholesale funding; supervisory action has mitigated the problem (e.g., rebalancing maturities), but many banks remain heavily exposed to a potential dry-up of unsecured wholesale funding. - Banks hold covered bonds issued by other banks as part of their liquidity buffer. - The EU implementation of the Liquidity Coverage Ratio, being more generous than Basel III on covered bond eligibility in the buffer, favors high levels of covered bond cross-holdings among banks, especially in the wider Nordic area. - This cross-holding could become a particular source of contagion if a drastic correction in house prices undermines market confidence in the covered bond sector. - While concentration risk and high reliance on covered bonds in liquidity buffers is being addressed in individual SREP decisions, systemic risk from bond cross-holdings has not been adequately addressed and lends itself to EU-wide analysis and potential supervisory action (e.g., via supervisory colleges or regional macroprudential fora). ### Key recommendations — Main Recommendations - 1. Ensure that the Finnish legislation grants the FIN-FSA all the powers it needs according to the CRD to impose decisions on capital and liquidity requirements and supervisory measures on LSIs. (MoF) NT - 2. Increase the number of supervisory staff to accommodate the SSM demands of FSA staff on JSTs and inspection teams, and in response to the more intense supervision expected for LSIs. (FSA) MT - 3. Strengthen the legal protection of the FSA officials and staff. (MoF, BoF) NT - 4. Seek a supervisory memorandum of understanding with the Swedish authorities covering large significant foreign branches, providing for enhanced access to information and supervisory engagement with the branches and parent banks. (ECB, FSA) NT - 5. Raise with the European Commission the question of how the CRD might be amended to retain the original objective of encouraging the free flow of financial services within the EU while, at the same time, providing host supervisors with additional authority over systemically-important institutions, in close collaboration with the home supervisor. (MoF, ECB) MT - 6. Proceed with the announced comprehensive review of banks’ internal models and devise, for the future, a sustainable form of ongoing model monitoring to prevent banks from reducing again the degree of conservatism in their models. (ECB, FSA) MT - 7. Analyze, within the SSM and in collaboration with the other supervisors in the EU, the risks possibly stemming from the crossholding of bonds, in particular covered bonds and consider imposing concentration limits. (ECB, FSA) MT - 8. Implement a regular data collection of individual loan files (e.g., a loan registry system) to better support the analysis of credit risk. (FSA) MT ### Key recommendations — Other Recommendations - 9. Reinforce FIN-FSA independence, by ensuring future Board members have diverse background and experience and are not concurrently serving in politically appointed positions. (MoF) MT - 10. Continue to closely monitor banks’ loan portfolios to verify the evolution of renegotiated loans. (ECB, FSA) NT - 11. Update the on-site methodology to ensure that the samples of loan files analyzed during inspections are selected according to statistically robust criteria. (ECB) MT - 12. Establish a regular program to directly verify the correct classification and valuation of fair-valued positions and any consequent need for additional valuation adjustments in banks with consistent amounts of Level 2 and 3 assets. (ECB, FSA) MT - 13. Closely monitor the impact on the bank’s loss absorbency of the ‘Danish compromise’ waiver (allowing banks in financial conglomerates not to deduct insurance participations). (ECB) NT - 14. Analyze the impact of the proposed law restraining municipalities tax-raising powers on Municipality Finance and the other banks. (ECB, FSA) NT - 15. Ensure that the need for consistency of the supervisory methods and techniques does not distract energy, time and resources from more risk-focused tasks (ECB) NT - 16. Improve the communication with the banks, including with respect to the outcome of the SREP. (ECB, FSA) MT - 17. Improve the external communication strategy to further highlight the specificities of the SSM, especially as regards the difference between SIs and LSIs. (ECB, FSA) MT NT = Near Term (within 6 months / 1 year); MT = Medium Term (within 2-3 years) *Source: IMF staff report (2016 FSAP mission) — EXECUTIVE SUMMARY* ### 7. The Financial Services Authority (Finanssivalvonta or FIN-FSA) is the supervisory ### 7. The Financial Services Authority (Finanssivalvonta or FIN-FSA) is the supervisory ### FIN-FSA mandate, governance, and decision-making - FIN-FSA is the supervisory authority for Finland’s financial sectors; the Director General participates in the Supervisory Board of the SSM. - Entities supervised include banks, insurance and pension companies, other companies operating in the insurance sector, investment firms, fund management companies and the Helsinki Stock Exchange. - Four Finnish banks are considered significant and are subject to direct prudential supervision by the ECB, in collaboration with the FIN-FSA and, to the extent they have cross-border operations, other relevant NCAs. - An additional 12 Finnish banks are designated as LSIs and are directly supervised by FIN-FSA under the oversight of the ECB. - FIN-FSA is formally under the administration of the Bank of Finland, but decision-making in supervisory matters is independent. - The FIN-FSA Board: - Is composed of five members appointed by Parliamentary Supervisory Council for a three-year term. - Is chaired by the Deputy Governor of the Bank of Finland. - Includes one nominee each from the Ministry of Finance, the Ministry of Social Affairs and Health, and the Bank of Finland; two independent members are chosen by the Parliamentary Supervisory Council. - Provides the Parliamentary Supervisory Council once a year with a report on the operational objectives of FIN-FSA and their achievement. - Develops the proposed budget of FIN-FSA and submits it to the Board of the Bank of Finland for confirmation; the Board generally approves it with no modification. - Approves regulations proposed by FIN-FSA and decides on penalty payments and other administrative sanctions except where the ECB has competence. - The Director General (DG): - Is appointed and may be dismissed by the Parliamentary Supervisory Council on the recommendation of the Board. - Has a term of office of five years. - Is responsible for managing the activities of FIN-FSA and must keep the Board informed, in advance, of far-reaching decisions or specific supervisory actions that restrict a supervised entity’s activities or affect its capital. - Observed governance issue: - From the perspective of best international practices on operational independence, the composition of the Board—with officials from Ministry of Finance and Ministry of Social Affairs serving as board members—creates the appearance of a lack of independence. - While no inappropriate interference was identified, appointing Board members in the future from outside government would reduce perceived risks of potential conflicts. ### Market structure of Finland’s banking system - Total banking system assets are equivalent to 230 percent of GDP. - Two-thirds of banking assets are in foreign-owned banks. - There are approximately 250 credit institutions in Finland; most are local co-operative or savings banks belonging to amalgamations (OP Group, Savings Banks Group and POP Banks Group). - Eight other banking groups include Nordea Bank Finland (NBF) and Danske Bank (DB) as foreign-owned groups; other groups include Aktia Bank, S-Bank, Bank of Åland plc, Oma Savings bank, Hypo Group, and Evli. - OP Group, Nordea Bank Finland (NBF), and Danske Bank account for more than 85 percent of the market in terms of assets and deposits. - OP, NBF, and DB are three of the four Significant Institutions (SIs) subject to direct supervision by the ECB within the SSM; the fourth SI, designated at the beginning of 2016, is Municipality Finance (MF), a non-deposit taking credit institution jointly owned by municipalities with assets representing around 6.6 percent of the banking system. - Banks generally hold universal banking licenses but concentrate on retail banking; housing loans represent approximately half of banks' loan portfolios. - Net interest margin (NIM) is the most important source of income; reductions in NIM have been partly offset by commission fees, trading income, and revenues from insurance activities. - Cost cutting has helped keep the cost/income ratio under control. ### Financial linkages, cross-border exposures, and funding composition - Significant financial linkages exist between some banks and non-bank financial firms; many non-bank financial firms are part of financial conglomerates (e.g., OP Group and Sampo Group exposures and equity holdings). - Cross-border exposures: - Cross-border exposures include assets of around 120 percent and liabilities of more than 150 percent of GDP. - Majority of cross-border exposures are to the Nordic region; there are considerable exposures to U.K. and other European countries. - Most cross-border claims are between banks and financial institutions. - Cross-border derivatives amount to 23 percent of banks’ total liabilities. - Excluding derivatives, two thirds of cross-border exposures are in loans and deposits, and one third are in debt securities. - Largest currency exposure is in euros, followed by U.S. dollars and other Nordic currencies. - Wholesale funding role and composition: - Loan-to-deposit ratio is 124 percent. - Wholesale funding accounts for more than half of banks’ funding. - Principal wholesale instruments and shares of total funding: deposits from credit institutions (20 percent), covered bonds (10 percent), senior unsecured bonds (10 percent), repo transactions (8 percent), and commercial paper/time deposits (6 percent). - A majority of wholesale funding is provided by foreign financial institutions, including parent banks. ### Credit risk, NPLs, coverage, and capital adequacy - Non-performing loans (NPLs): - Average NPL ratio is 1.57 percent of total loans (1.62 percent for SIs, 1.15 percent for LSIs). - Factors explaining low NPLs: banks’ flexibility to negotiate loan terms for clients in difficulty and entrenched payment culture. - Coverage ratios: - Coverage ratios are around 30 percent. - Low coverage is partially justified by Finnish specifics: in the mortgage segment foreclosure is rarely activated; banks prefer voluntary sales by defaulting customers. - Capital adequacy: - Overall capital adequacy ratio of the banking sector (excluding MF) increased to 23.1 percent at the end of 2015 from 17.3 percent at the end of 2014. - Common equity tier 1 (CET1) ratio was 21.0 percent at the end of 2015 (15.8 percent at the end of 2014). - Improvements due to organic growth (retained earnings), injections of new capital, and more extensive use of internal models reducing RWAs. - Credit risk density (RWAs for credit risk over total assets) has decreased significantly since 2007 when the first IRB models were approved. - While overall credit risk density of Finnish banks is close to the median in Europe, that for mortgage exposures is the lowest. ### Nordea branchification and expected market impact - A significant market structure change was anticipated as Nordea Bank Finland (NBF) planned to convert to a branch of Sweden’s Nordea Bank AB (NBAB). - Under “branchification,” foreign subsidiaries of Nordea would be merged into Nordea Bank AB and subsidiary assets shifted into branches of NBAB. - The conversion was expected to take place in early 2017 assuming satisfactory approvals from authorities in Denmark, Finland, and Norway. - Nordea Bank Finland had assets at year-end 2015 of €301.6 billion, almost threefold the next largest Finnish bank, OP Group. - Even after branchification, Nordea’s branch, along with a standalone mortgage credit subsidiary, was expected to have a market share of almost one-third of total deposits in Finland, making it the second largest bank in Finland. ### FIN-FSA internal organization and operational arrangements - FIN-FSA internal structure includes: - A department in charge of institutional supervision with ‘line’ supervisors for banks and non-banks. - A department for prudential supervision with risk specialists and other experts. - A department for the supervision of markets and business conduct. - A support unit for the DG. - The Board appoints heads of department; the DG appoints staff below heads of departments. - The DG is assisted by an advisory management group consisting of heads of department and other employees appointed by the DG. - FIN-FSA has not reorganized to mirror the ECB structure (no dedicated on-site inspection unit); on-site missions are staffed by supervisors and experts from relevant departments as appropriate. - This multitasking approach allows limited staff to cover more areas but results in fewer resources dedicated to on-site missions. - FIN-FSA staff have faced constraints participating in ECB-formed inspection teams for banks outside Finland and have not always been able to meet JST coordinators’ requests to staff inspection teams assigned to inspect Finnish SIs. ### FIN-FSA role in the SSM and Supervisory Board interactions - With the introduction of the SSM, FIN-FSA participates in the ECB Supervisory Board; the FIN-FSA Board appointed the DG as the FIN-FSA’s representative in the SB. - An Interagency Group questioned whether the FIN-FSA Board should be more involved in reviewing items that come before the ECB’s Supervisory Board (e.g., budget and funding of ECB supervisory function, significant supervisory decisions involving individual SIs, proposed SSM regulations and guidelines). - Observations: - Such involvement would conflict with SSM regulation expectations that SB members act exclusively in the interests of the Union and be independent and not subject to instructions or influence from government, any public or private body, or industry. - Given the volume of items and short notice for some items before meetings, it would be impractical for the FIN-FSA Board to play such a consultative role prior to Supervisory Board decisions. - Due to long delays in SSM decisions, it is important that the Supervisory Board operate independently and efficiently, enabling Members to decide on positions during meetings in the interests of the Union without prior consultation with their home authority. ### Demand on supervisory resources and implications of the SSM - Since the global financial crisis, supervisory resource requirements have increased due to: - The 2012 revision of the Basel Core Principles placing increased emphasis on the supervisory review process. - Basel III capital and liquidity standards introducing new supervisory requirements and enhanced prudential standards. - EBA guidelines and technical standards imposing minimum requirements and a higher degree of supervisory intrusiveness. - Greater supervisory intensity expected for systemically important banks and greater engagement between senior supervisors and banks’ senior management and boards. - The transfer of prudential supervision responsibility for the four major Finnish banks to the ECB has not reduced demands on FIN-FSA resources. - The SSM staffing model created Joint Supervisory Teams (JSTs) and separate on-site inspection teams: - JSTs are coordinated by ECB supervisors but staffed primarily by relevant NCA teams under NCA subcoordinators. - On-site inspection teams combine staff from NCAs and the ECB depending on expertise required. - The SSM places heavy reliance on local bank supervisors to staff both on-site inspections of SIs and JSTs to retain institutional knowledge of individual banks and local markets. - The ECB’s higher expectations of SI supervision have led to more intense and intrusive supervision—longer and more detailed examinations and more interaction with senior management on risk appetite, business strategies, and governance. - These higher expectations, while initially focused on SIs, are being gradually adopted by the ECB for FIN-FSA’s supervision of LSIs over time. - Net effect: creation of the SSM and designation of large banks as ECB-supervised SIs has not reduced FIN-FSA’s resource burden; it may have increased demand on supervisory resources. *Source: cr1703 - 7. The Financial Services Authority (Finanssivalvonta or FIN-FSA) is the supervisory* ### 32. With respect to LSIs, under the SSM model, these institutions remain the direct ### cr1703 - 32. With respect to LSIs, under the SSM model, these institutions remain the direct ### Supervisory responsibilities and coordination - LSIs remain the direct responsibility of the FIN-FSA to supervise, under the oversight of the ECB. - The ECB is introducing supervisory guidance for LSIs, in keeping with EBA policies and with input from the NCAs, leading many NCAs to increase time spent supervising LSIs since creation of the SSM. - Coordination time has increased for both SIs and LSIs: - For SIs: JSTs undertake day-to-day coordination between ECB and NCA components and engage in horizontal tasks (creation of common methodologies, frequent horizontal analyses) due to diversity of banks supervised and need for harmonization. - For LSIs: ECB oversight requires the FIN-FSA to ensure regular notifications and reporting, participate in periodical thematic reviews, and contribute to workshops, working groups, drafting teams. - Governance burden: - Both the head of each NCA and the central bank governor are expected to actively engage in Supervisory Board and Governing Council discussions and recommendations/decisions. - The Governing Council of the ECB has limited delegation and is directly involved in a relevant number of decisions: in 2015 more than 1,500 decisions were taken by the Governing Council (mostly via written procedure), half of which concerned the approval of appointments of Board members and senior managers. - Other decisions (e.g., SREP capital decisions, qualifying holdings) require heightened attention, imposing additional briefing burdens on senior financial sector staff across euro area countries. - Certain EA countries have set up a dedicated secretariat to handle the increased paper flow. ### Availability of supervisory resources (FIN-FSA staffing and capacity) - 2015 staffing: - FIN-FSA had staff totaling approximately 186 full-time equivalent (FTEs). - Approximately 60 FTEs are devoted to banking supervision. - Administrative support equivalent to another 21 FTEs for a total of 81 FTEs supporting banking supervision. - Experience and turnover: - Managers have on average 11 years of relevant experience. - Staff have an average of 12 years of supervisory experience. - Turnover among junior staff (less than 3 years of experience) was 22 percent in 2015. - Budget and efficiency context: - Staffing levels roughly flat since the last FSAP in 2010 and expected to remain the same over the next several years. - FIN-FSA has pursued efficiency gains amid government expectations of increasing public-sector efficiency and budget tightening; most of FIN-FSA’s budget is paid by the regulated industry, but this has not factored into budget decisions. - Budget has not been increased despite increased supervisory demands, constraining ability to cover supervisory activities in a financial sector of Finland’s size and complexity. - Evidence found of recent SSM inspections uncovering long-standing issues not previously targeted, attributed likely to resource constraints despite experienced supervisors. - Contribution to SSM workload: - FIN-FSA assigned approximately 33 FTEs to supervisory tasks (off-site and on-site) and 35 FTEs to other SSM-related tasks (horizontal activities, statistics, financial stability, IT, etc.). - Of those dedicated to supervisory tasks, 13 FTEs were assigned to the JSTs supervising the Finnish SIs. - Those 13 FTEs were comprised of 33 different individuals with allocations of time ranging between 10 and 90 percent, for an average of around 40 percent. - Using multiple staff part time rather than dedicated staff increases efficiency losses; staff allocations of time below 50 percent jeopardize productivity. - In two JSTs the FTEs assigned for supervision of other non-Finnish banks are more than double those assigned to Finnish ones despite similar size and lower complexity of the non-Finnish banks. - Future staffing and fee considerations: - The FSA Board preliminarily indicated intent to modestly reduce staff over the next several years in line with government policy on tight budgets and reduced public spending. - Proposed restructuring of Nordea from subsidiary to branch will reduce Nordea asset base in Finland and reduce fees to FIN-FSA, given assets will be in a branch rather than a bank. - Government intention is to offset fee reduction by revising legislation governing the fee schedule so FIN-FSA budget will not need to be reduced; government would agree to cap any future increase in bank fees to roughly current levels. - This fee cap measure could put more pressure on FIN-FSA’s budget in the future. - Recommendation: - It is recommended that the FSA gradually increases the number of its supervisory staff to accommodate demands of the ECB for FSA staff to supervise SIs and the more intense supervision expected for LSIs. - Legal protection: - Legal protection for FSA officials and staff should be strengthened. - Under Finnish law the State is ultimately liable for damages suffered by third parties and has recourse to officials and staff if damages caused by their actions or omissions. - Finnish financial sector legislation does not include clauses to provide officials and staff legal protection for actions and omissions in good faith in the exercise of their official duties; the Finnish equivalent of “good faith” needs determination and enshrinement in legislation, followed by operational arrangements to make protection effective. ### Supervisory approach — Significant Institutions (SIs) - SSM supervisory process: - Based on EU-wide SREP as prescribed by the CRD (art. 97 and following), follows the EBA Guidelines on SREP, and further detailed in the SSM supervisory manual. - Applied at consolidated, sub-consolidated and single-entity levels (unless an entity waived from supervision per Articles 7, 8, 10 of the CRR). - Relies on quantitative and qualitative analysis combining data (form FINREP, COREP, and other standard reports) and expert judgment. - Joint Supervisory Teams (JSTs): - Each SI is supervised by a JST led by an ECB coordinator, comprising staff from the ECB and involved NCAs. - JSTs undertake day-to-day supervision and conduct yearly SREPs, reporting to the ECB Supervisory Board which recommends final decisions on capital and liquidity to the Governing Council. - SREP elements (four): a. business model and profitability assessment; b. internal governance and risk management assessment; c. risk-by-risk assessment of risks to capital; d. risk-by-risk assessment of risks to liquidity and funding. - Assessment process: - Each SREP element assessed via: (i) data gathering; (ii) automated anchoring score from the Risk Assessment System (RAS); (iii) supervisory judgment allowing adjustment of automatic scores based on additional factors and bank specifics. - Risk-to-capital analysis combines three perspectives: supervisory (RAS), bank (ICAAP), and forward-looking (bank stress-test compared with supervisory stress tests). - SSM methodology provides ‘supervisory proxies’ for specific risks: credit risk (simplified Credit VaR), single name concentration risk, sector concentration risk, market risk (simplified VaR and Stressed VaR), IRRBB, and operational risk. - Frequency and linkage to supervisory measures: - Assessments of the four SREP elements performed at least annually and result in an overall SREP assessment that underpins supervisory actions (capital decision, liquidity decision, other qualitative or quantitative measures). - JSTs exercise judgment and may incorporate previous year’s SREP score or peer comparisons. - Supervisory assessment links to the Supervisory Examination Program (SEP): - Annual planning starts with supervisory priorities, categorization of banks by systemic footprint (6 ‘clusters’) and SREP scores on a 1–4 scale. - SEP decides minimum engagement levels (MEL) and core activities risk by risk; JSTs add additional SEP activities as needed. - SEP includes an annual schedule of key meetings with group management and significant subsidiaries, applying minimum engagement and proportionality principles. - On-site inspections organizationally independent but coordinated with JSTs. - On-site inspections in Finland (2015): - Eight on-site inspections on Finnish SIs. - Topics: asset classification (nonperforming exposures, forbearance) and provisioning; governance and risk management; operational risk management and risk control systems; liquidity risk; and IT issues. - Average duration of visits varied, with a tendency to increase, converging towards SSM standard (approximately five weeks). - Missions staffed on average with four to five persons. - Standardization concerns: - Standardization of supervisory methods (e.g., checklists) necessary for comparability and convergence but may risk shifting to excessive compliance-based techniques and distract from risk-focused tasks. - Industry feedback: - Overall improvement in supervision level, but communication between supervisors and banks has room for improvement (e.g., better explanation of purpose and final use of data collections would help banks meet requests). - Feedback (e.g., benchmarking) found helpful by banks. - Public understanding issues: the larger public struggles to understand division of responsibilities between supervisory agencies and may assume NCAs continue responsibility for SIs. ### Supervisory approach — Less Significant Institutions (LSIs) - FIN-FSA has benefited from participation in the SSM; supervisory approach in Finland was considerably less structured, intense, and intrusive before SSM. - SREP for Finnish LSIs: - Consistent with EBA guidelines and gradually converging to the SSM approach. - SREP frequency: annual for high priority LSIs; every 2 or 3 years for other LSIs. - Planning and ongoing supervision: - FIN-FSA uses an annual planning process for off-site supervision and a separate bi-annual planning process for on-site inspections, reflecting supervisory findings. - Ongoing supervision includes meetings with banks, review of regulatory reports, bank internal reports and other relevant information. - Frequency of meetings with boards, senior management and internal audit depends on bank importance and riskiness. - FIN-FSA holds a bi-annual press conference presenting the situation of the financial sector. *International Monetary Fund — Finland: selected excerpts from cr1703* ### 60. The assessment of banks’ situation is based on two rating systems: an automatic ### The assessment of banks’ situation is based on two rating systems: an automatic ### Rating systems and supervisory framework - Two rating systems: - an automatic quarterly indicator-based rating focused on five areas: capital adequacy, profitability, credit risk, liquidity, and IRRBB. - a comprehensive SREP rating system combining individual risk indicators and other information on the supervised entity. - Automatic rating outcomes and relating actions (four possible outcomes): - normal supervision; - enhanced supervision (including, for example, contacting the supervised entity and more frequent reporting); - early corrective actions (like a requirement for the bank to hold own funds in excess of its capital requirements or to restrict distributions to shareholders); - special corrective actions (including immediate corrective actions, special external auditing, and special administrator). - SREP practice: - Currently, the overall SREP rating is primarily based on the assessment of the supervisory expert and supported by risk indicators. - FIN-FSA is updating the LSI SREP process to better align with the EBA SREP Guidelines, including developing supervisory ‘proxies’ to challenge banks’ ICAAP measurement of IRRBB, spread risk and concentration risk. ### On-site inspections and supervisory approach - FIN-FSA convergence toward SSM approach: - In 2015 there have been 23 on-site inspections on LSIs. - Transition from minimizing time on premises and desk-based analysis toward leveraging on-site time to interact with middle management and staff and observe IT systems. - FSA staff noted the resource-intensive and time consuming nature of the new approach but praised the heightened focus and insight it allows. - Credit file reviews: - Performed during on-site inspections with sampling of credit files and financial analysis; procedures defined in pre-inspection phase by JST and Head of Mission. - Data on loan losses (write-downs), extensions/rollovers, restructured loans, and nonperforming exposures can be collected according to the mandate. - In 2015–2016 inspections were conducted, in particular, on two SIs and one LSI to verify application of the rules on forbearance. - Limitations: - Non-statistical samples limit extrapolation and follow-up; lack of a benchmark ratio (e.g., NPL ratio) from samples hinders monitoring via periodical reports. - SSM is updating the SSM Manual to provide a common credit risk on-site methodology covering sampling, classification of exposures, assessment of individual and collective provisioning, and evaluation of collateral. ### Supplementary supervision on financial conglomerates - Regulatory basis: - As a EU member, Finland has implemented the Financial Conglomerates Directive. Supplementary supervision covers four areas: capital adequacy; risk concentration; intra-group transactions; internal control mechanisms and risk management processes. - Identified conglomerates and coordinators: - Five conglomerates have been identified in Finland. - Two groups headed by banks: OP and Aktia. - Two headed by insurance companies and comprising Finnish banks: Sampo (major shareholder of Nordea AB) and Lahi Tapiola (which holds a participation in S-bank). - Taaleri is a conglomerate headed by an insurance company with no banks in the group. - ECB is the coordinator for OP, FIN-FSA for the remaining four. - FIN-FSA supplementary supervision activities: - Calculates capital available in each conglomerate and sectoral capital requirements to determine overall solvency position. - Overviews most relevant intra-group transactions and degree of risk concentration. - Conducts comprehensive risk assessment assigning scores to various profiles depending on importance of different forms of risk. - For OP, coordination required between the ECB and the insurance supervision function of FIN-FSA. - CRR art. 49 (‘Danish’ compromise) and implications: - CRR (art. 49) grants member states the option to allow banking groups that are part of a financial conglomerate not to deduct their participation in insurance companies. - CRR deviates from the Basel framework in that the CRD does not require the alternative method to result in a not-higher level of calculated capital. - The waiver has been granted to one of the two Finnish banking groups part of a conglomerate. - Based on ECB calculations, the exemption determines a material increase in the banking group’s capital ratios with respect to the case of deduction. - The impact of the waiver on the group’s capital should be taken into account (at least qualitatively) when assessing its capital adequacy. *Source: IMF staff report text.* ### Capital — Credit risk (Significant institutions) - Data availability and monitoring: - Supervision on credit risk is based on an overall robust process supported by adequate supervisory techniques, but lacks availability of individual loan file data on a regular basis. - Aggregate data on lending are available from FINREP and COREP; more granular data needed. Individual loan information for corporate lending will be available through the EA-wide AnaCredit project. - EBA Guidelines on SREP: - Supervisors required to assess overall credit quality at portfolio level and quality grades within “performing”, “nonperforming”, and “forborne.” - Supervisors recommended to use EBA definitions as benchmark. - Credit file reviews and supervisory powers: - Credit file reviews performed during on-site inspections with sampling to confirm borrower’s ability to repay. - ECB can require SIs to adjust their provisioning. Art. 104 CRD establishes that competent authorities should have the power to require institutions to apply a specific provisioning policy or treatment of assets and, where permitted, require it to increase provisions. - ECB bases its power to require additional provisioning (for prudential purposes) on Art. 16(2) of the SSMR. - Recent consumer-mortgage developments and metrics: - Volumes of renegotiated loans to households were especially high during the first half of 2015 with respect to the corresponding monthly level in 2014 due to a dedicated campaign by a large mortgage lender granting one-year grace periods from paying principal (provided borrowers met risk criteria). - Following termination of amortization holidays for some 14 percent of mortgages, interest-only mortgages now account for less than 4 percent of the total. - After dedicated campaigns ended in Q3/2015, volumes of renegotiated loans have remained at around four times the pre-campaign level. - Supervisors require heightened vigilance on evolution in the ‘grey area’ of renegotiated and forborne loans. ### Credit risk (Less Significant Institutions) - Supervisory approach: - For LSIs, FIN-FSA relies on the EBA guidelines on SREP and its standard on Credit Risk Management (4.4a). - FIN-FSA adopts EBA definitions of forborne and non-performing exposures. - Limitations of FIN-FSA powers and data: - FIN-FSA does not have the authority to impose additional own funds requirements to compensate for inadequate provisions; it can give orders of a technical accounting nature regarding IAS 39 implementation but cannot go beyond that. - Lack of granular data on household loans limits monitoring (e.g., of renegotiated loans). Finland has no central credit register; a credit bureau operates but is only of ‘negative’ nature. - FIN-FSA does not receive regular reporting on defaults of individual counterparties; such information is requested in connection with credit risk inspections. - A new data collection starting in Q3 2016 will require banks to report information on new housing loans and the relative collateral, enabling monitoring of loan-to-collateral (LTC) and LTV for new lending; FIN-FSA will still lack detailed information on collateral backing existing loans and on the stock of renegotiated loans. ### Internal models for credit risk - IRB model landscape: - There are currently five banking groups with approved IRB models in Finland. Models cover portfolios including Corporate, Retail, and Institutions. - First IRB models were approved in 2007; further approvals followed in subsequent years. - Risk-weight trends and metrics: - Credit risk density (ratio between credit risk-weighted assets and total assets) dropped from 34.7 percent at the end of 2008 to 18.6 percent at the end of 2015. - Finnish banks’ average risk densities are in line with the median for the EU, but those for mortgages are much lower. - Supervisory monitoring and mitigation: - Ongoing monitoring of internal models has been limited in years following approvals, likely due to supervisory resource constraints, potentially resulting in inadequate capitalization of IRB banks and compromised ‘level playing field’. - In June 2016 the FIN-FSA Board decided to introduce a floor of 10 percent for the average risk weight on housing loans of IRB banks. This minimum level would come into force on 1 July 2017 at the latest. - Concerns about floors: - A floor might not be sufficiently conservative if the appropriate risk weight is higher than the floor. - A floor could incentivize regulatory arbitrage, e.g., banks with average risk weight below the floor might expand toward riskier exposures to reach the floor. - SSM roles and OMM: - In the SSM, model approvals and ongoing model monitoring (OMM) are distinct: JSTs are responsible for OMM; individual model approvals fall within remit of project manager designated by JST coordinator. - SSM supervisory manual defines OMM as a “permanent legal requirement” and “continuous process”; JSTs must create standard summary reports on model characteristics, compliance, and need for supervisory measures. OMM outcomes should be integrated into SREP at least annually. - Global supervisory experience shows OMM is at risk of receiving insufficient attention once models are approved; maintaining supervisory attention and resources for OMM is a challenge. *Source: IMF staff report text.* ### 86. The approach established by the supervisory manual for OMM appears appropriate, ### cr1703 - 86. The approach established by the supervisory manual for OMM appears appropriate, ### Ongoing Model Monitoring (OMM) — staffing, implementation, and risks - Internal review on the staffing and skills of JSTs, concluded in December 2015 and based also on the results of an internal survey, found that: - "almost one-third of the respondents were very dissatisfied with respect to the adequacy of JSTs to perform on-going monitoring of models;" - "the average degree of dissatisfaction was lower (14 percent of very dissatisfied) as regards the adequacy to follow up on reports by the Internal Models division (INM)." - The report observed dissatisfaction appears less linked to perceived inadequacy of available skills within JSTs and more to other aspects, including: - "the overall number of resources [which] seems to influence the JSTs adequacy to perform INM-related tasks;" - the relative inexperience of many teams with model-related issues at the time of the survey. - Anecdotal evidence indicates JSTs, already busy with day-to-day supervision, find it challenging to conduct satisfactory ongoing model monitoring; INM investigations can often represent the only feasible opportunity for a JST to gain appropriate insight into internal models and identify shortcomings. - Implication: resource constraints and limited experience can materially affect implementation of the supervisory manual for OMM. ### TRIM (Targeted Review of Internal Models) — scope, purpose, and steady-state concerns - The report calls for an urgent Euro area-wide review of banks’ internal models; this is materializing through the ECB ‘TRIM’ project: - planning is ongoing and execution is expected "in the next two years." - the project aims at a targeted review of select issues of the most relevant internal models, especially for credit risk, selected according to established criteria of materiality and criticality. - TRIM is characterized as a valid and extraordinary measure to address: - lack of comparability between models across the SSM stemming from a wide range of pre-SSM practices; - situations where banks may have reduced model conservatism to "optimize" their RWAs. - Risk: without specific solutions for the "steady state," results achieved by TRIM may dissipate in the post-project phase. - Recommended steady-state complements to TRIM (implied by the text): - resource adjustments for JSTs to sustain ongoing monitoring; - development of tools, e.g., standardization of the benchmarking exercise; - process improvements, e.g., more detailed description on how banks’ internal validation reports should be processed. - Note: "The Internal Models division seems to be aware of the need to invest also in this direction." ### Market risk — supervisory guidance, valuation verification, and exposures - EBA Guidelines on SREP specify market risk management elements supervisors need to assess, including: market risk strategies and risk appetite; organizational frameworks; policies and procedures; risk identification, measurement, monitoring and reporting; and internal control framework. - The SSM manual structures market risk assessment across four dimensions: governance, risk appetite, risk management and internal controls, and internal audit. - Verification and valuation practices: - JSTs can and do verify banks’ classification of assets according to the Fair Value Hierarchy (FVH), but "no investigations on valuations have been conducted so far." - FVH correctness was mainly checked during the 2014 Comprehensive Assessment; JSTs include further checks in planned on-site visits when needed. - There is not a regular program to directly verify valuation of fair-valued positions and any consequent need for additional valuation adjustments. - Internal model investigations can include price verifications on selected samples to challenge banks’ internal pricing models. - Supervisors maintain dialogue with banks’ auditors and can call for external auditors/experts to perform valuation investigations under the responsibility of the SSM Head of Mission. - FIN-FSA market risk supervision: - based on the standard "Management of market risk" (4.4c) and on the EBA SREP guidelines; - applied to all market risks regardless of trading book/non-trading book or trading activity level; - planning of on-site investigations is risk based. - Market risk has not been a focus in LSI institutions; last market risk inspection was in 2012. Two market risk investigations for LSIs are planned for 2016. - Derivatives exposures in Finland: - a considerable share of derivative contracts is cleared through clearing houses; banks are mainly exposed to one CCP, LCH Clearnet. - Finnish banks have substantial derivatives exposures towards large international investment banks. - "the bulk of derivative exposures (more than 90 percent of the whole banking system) is currently represented by the derivative book of NBF, which serves as a hub for the banking group." - As part of the announced transformation of NBF into a branch, the whole book will be transferred to the parent company in Sweden; once completed, the derivative exposure of the Finnish banking system will considerably drop. ### Decisions on capital — legal powers, SREP process, disclosure, and capitalization indices - CRD requirements and supervisory powers: - CRD requires competent authorities to determine whether banks can ensure sound management and coverage of risks and to intervene at an early stage to address problems that determine an actual breach of CRD and CRR provisions or a likely breach in the next 12 months. - Supervisors can require a bank to hold own funds in excess of Pillar 1 capital requirements ("Pillar 2 capital add-ons")22 and to apply specific provisioning policies or treatments in capital requirements. - Finnish legislative transposition issues: - FIN-FSA-assigned powers under Finnish legislation are "somehow more limited" than those granted to the ECB by SSM regulation. - Transposition of article 104 CRD appears across the Act on Credit Institution (Act 610/2014) but does not ensure FIN-FSA can impose CRD-foreseen supervisory measures on LSIs. - Example: discretionary capital add-on application is subjected to either a material deficiency in how the bank assessed capital needs or inadequacy of own funds to cover its ICAAP estimate (Chapter 1, Section 6) — the latter being an internal assessment and thus not aligned with the letter and spirit of the CRD. - The Act’s formulation may prevent FIN-FSA from imposing add-ons to address potential breaches of other CRD/CRR provisions (e.g., material deficiencies in internal governance) or adjustments to provisioning for prudential purposes. - SREP decision-making process and communication: - The decision to alter a bank’s capital requirement is based on the SREP; for groups with subsidiaries outside the euro area and EA subsidiaries of non-EA banks, the report is shared within the supervisory college. - The decision is communicated via a legally binding SREP letter that carries motivations. JSTs are encouraged to meet bank management to present SREP conclusions and rationale. - SREP process phases: preparation, evaluation, and decision: - Preparation: JSTs collect relevant information such as ICAAP and ILAAP reports. - Evaluation: JSTs assign SREP scores and prepare draft Group Risk Assessment and Group Liquidity Risk Assessment Reports using end year COREP data and STE data. - Decision: JSTs prepare draft SREP decisions; drafts submitted to Supervisory Board for approval; after approval a two weeks hearing period starts; JSTs and horizontal functions assess comments and may incorporate them; draft decisions are sent to Supervisory Board and thereafter to the Governing Council for final approval via non-objection procedure. - Evolution of methodologies and expectations: - 2014 SREP on SIs used national RAS due to lack of common methodology. - 2015: a single risk assessment methodology was used for the first time (based on 2014-end data), but ICAAPs and stress tests were downplayed due to heterogeneity across banks. - 2016 ECB plans to incorporate three "blocks" into SREP assessments: - Block 1: the supervisor’s perspective; - Block 2: the bank’s perspective (ICAAP/ILAAP); - Block 3: a forward-looking perspective via bank’s own stress test compared with and challenged by the supervisory stress test. - January 2016 ECB note made expectations explicit on ICAAPs and ILAAPs for 2016, defining baseline expectations across nine ICAAP areas. - Communication and disclosure: - Current SSM policy allows JSTs to share overall SREP scores informally with banks; this policy might be reconsidered. - Improved communication of SREP scores (without disclosing methodology) could mitigate banks’ uncertainty and improve dialogue. - 2015 position: banks were required not to disclose SREP content unless compelled by national laws or regulation; EBA opinion (December 2015) suggests authorities should consider requiring banks to disclose their capital requirements when relevant for determining the maximum distributable amount of profits or at least not prevent banks from disclosing this information. - Capitalization indices and transparency: - Due to stratification of capital requirements (Pillar 2 add-ons, capital conservation buffer, counter-cyclical buffer, G-SIB buffer23, systemic buffer24, O-SII buffer), traditional capital ratios (own funds to Pillar 1 RWAs) are increasingly less meaningful and potentially misleading. - Recommendation: move to an index approach calculated as the ratio of own funds to the whole of the capital requirements (as for the LCR), which would allow straightforward representation of solvency (health measured by how much above 100 percent the capital index lies). - Current assessment: - "In the current situation Finnish banks’ capitalization appears adequate," but supervisors should remain vigilant to: - deterioration of loan portfolios from negative macrofinancial developments; - potential underestimation of risks by IRB banks; - potential impact of draft law capping Finnish municipalities’ tax-raising powers, which could affect MF and other banks depending on MF securities in their portfolios. ### Liquidity and Funding — improvements, persistent vulnerabilities, and supervisory tools - Overall assessment: - The regulatory and supervisory framework for liquidity and funding risk has improved since the last FSAP, but "certain vulnerabilities persist and require greater attention." - Implementation of LCR and NSFR requirements in the EU, and additional monitoring metrics, will provide clearer and more regular pictures of liquidity and funding risks. - Longstanding issue: high reliance on wholesale funding. - Emerging issues: sizable crossholdings and concentration of covered bonds. - Reporting and monitoring: - SSM requires banks to report their Liquidity Coverage ratio (LCR) and other liquidity/funding information quarterly; starting in the third quarter of 2016, these reports will be monthly. - Liquidity position is monitored and assessed at least annually as part of the SREP. - Limits to asset-liability mismatch are addressed in part through the LCR and more comprehensively through future binding NSFR requirements. - Supervisors may apply additional requirements above the minimum as part of SREP outcomes. - Controls and assessments: - Quality of liquidity risk management controls, including contingency planning, is covered at least annually through SREP. - Supervisors cover topics from basic compliance to technical aspects of liquidity risk management; on-site inspections may be performed with support from a comprehensive and separate methodology. - Perspectives in analysis: - Liquidity and funding analysis encompasses three perspectives: - supervisory perspective based on RAS indicators (including LCR) producing an automatic score; - bank’s perspective based on ILAAP; - forward-looking perspective based on bank’s own stress-test compared with supervisory stress tests. - A standardized stress scenario, applied across all SIs, incorporates retail and wholesale stresses and allows benchmarking. - FIN-FSA for LSIs: - Finnish LSIs must comply with the FIN-FSA standard "Management of Liquidity Risk" (4.4d), covering liquidity strategy, risk management, controls, liquidity buffer, stress testing and scenarios, contingency funding plan, and disclosure. - Liquidity risks are monitored and assessed annually by FIN-FSA as part of SREP and through a quarterly monitoring report. - An ongoing FIN-FSA project aims to develop stress tests/tools, including a LCR sensitivity tool, a survival horizon tool and a NSRF sensitivity tool. - On-site inspections may be performed on specific liquidity risk management topics. *Italic: Excerpt from IMF Financial Sector Assessment Program report chapter on Finland contained in the source content unit.* ### 113. The FIN-FSA initiated a thematic review on LCR and ILAAP in May 2016. It aims at ### The FIN-FSA thematic review on LCR and ILAAP and related supervisory issues ### LCR and ILAAP thematic review - The FIN-FSA initiated a thematic review on LCR and ILAAP in May 2016. - Objectives: - Verifying banks’ compliance with the regulation on liquidity risk. - Assessing the quality of liquidity management. - Establishing a common understanding of ILAAP in the industry and improve its quality. - Possible follow-up actions: - Supervisory visits or inspections, if needed. - Feed the SREP, including for determining any additional liquidity requirements. ### EU LCR implementation, scope and deviations from BCBS - Implementation and phasing: - The LCR requirement is in force in the EU since October 2015. - Applied at consolidated and individual level. - Subject to phase-in: from 70 percent of the requirement as of January 2016 to 100 percent from January 2018. - CRR granted EU member states the option to speed up the phase-in (which started from a minimum requirement of 60 percent and is meant to reach 100 percent only in 2018); this means that currently the minimum requirement differs across the SSM. - Commission delegated regulation (EU) 2015/61 (DA) supplements the CRR with regard to the LCR and provides details. - Key EU deviations from the Basel standard that widen HQLA eligibility (DA Articles referenced): - Covered bonds rated AA– or above included in Level 1 HQLA with a 7 percent haircut and a cap of 70 percent (DA Article 10); if rated between A– and A+ they are eligible for level 2A with a 15 percent haircut. - In Basel standard covered bonds rated AA– or above are eligible only as Level 2A HQLA, subject to a 15 percent haircut and Level 2A can represent no more than 40 percent of overall HQLA. - Non-externally rated covered bonds included in Level 2B HQLA with a 30 percent haircut (DA Article 12). - Assets and representing claims to or guaranteed by the central government, the central bank, regional governments, local authorities or public sector entities (PSEs) of a Member State are included in Level 1 HQLA even if they are not marketable securities (DA Article 10). - Instruments from securitization of auto, SME and consumer loans are included in Level 2B HQLA (DA Article 13), whereas in the Basel standard residential mortgage backed securities are the only securitization instruments eligible as Level 2B. - More conservative EU treatments versus Basel: - Application of 15–20 percent run off rates for certain retail deposits. - The 3 percent outflow rate for stable retail deposits cannot be applied during the phase-in period. - Net effect of deviations: - The deviations lead to a loosening of the requirement. - EBA calculation (EBA 2014 LCR IA Report, December 2014): deviations lead to increase in LCR of 13.9 percentage points for all the sample banks (322) and a decline in the number of banks failing to meet the 100 percent LCR from 74 to 17. - The analysis shows the impact from the increase in the HQLA 2B instruments is by far the biggest. ### Covered bonds: concentration, contagion risk, and asset encumbrance - Current situation and vulnerabilities: - Sizable holdings of covered bonds average around 30 percent of Finnish banks’ liquid assets, representing a potential vulnerability. - Supervisors require banks to calculate LCR by currency, at least for the most significant currencies. - The more generous eligibility of covered bonds in the liquidity buffer provides an incentive to stockpile liquidity in this form. - Instances of excessive concentration: - Concentration on a single type of product and on a restricted range of issuers (mostly from the Nordic area), and in certain cases on a single issuer (even above 95 percent), increasing exposure to extreme events. - Contagion and regional concerns: - High level of covered bonds cross-holding in the Nordic area could be a particular source of contagion should a major correction in house prices materialize in the region and undermine market confidence in the covered bond sector. - This risk does not appear to have been specifically addressed so far. - Given its cross-border nature, it lends itself to a coordinated regional analysis and, if needed, action by relevant supervisors (e.g., through collaboration in supervisory colleges or macroprudential fora). - Policy consideration: the imposition of concentration limits on covered bonds should be considered. - Asset encumbrance: - Intense issuance of covered bonds also represents a source of potentially significant asset encumbrance, which authorities should continue to monitor and prepare to specifically address. - Current reporting allows monitoring the evolution of asset encumbrance; however, a common methodology should be created to establish what levels of encumbrance should raise an alarm and which specific supervisory action should ensue. ### Funding structure and supervisory focus on liquidity risk management - Wholesale funding and loan/deposit metrics: - High reliance on wholesale funding remains characteristic of the Finnish banking system. - The loan/deposit ratio has continued to decline in the past years, though it is still higher than 120 percent. - Share of foreign counterparts in wholesale funding is very high: 78 percent for the whole system (partly due to large intragroup exposures of major subsidiaries and branches of foreign banks). - Supervisory actions and expectations: - Supervisors have engaged banks on risk management practices, requiring: - Wider diversification of funding in terms of counterparts, maturities, and currencies. - Monitoring of intragroup liquidity flows. - Extension of liquidity survival horizon. - Preparation of adequate contingency plans. - Particular attention to reduction in the short-term component of wholesale funding. ### Enforcement and sanctioning framework under the SSM and in Finland - Framework status: - Enforcement and sanctioning framework has been reinforced, though functionality is yet to be tested in light of the complexity of the SSM arrangements. - Powers expanded in national legislation, including through CRD transposition. - SSM framework is based on a combination of powers assigned either to the ECB or the National Competent Authorities (NCAs), with the latter not being fully harmonized. - Where the ECB lacks powers to directly impose enforcement measures or sanctions on banks, it can request or instruct NCAs to act based on available powers. - This complex arrangement has not been put to the test so far in Finland; at the time of the FSAP mission no enforcement measures or sanctions had been imposed by the ECB on any SI in the SSM. - Types of actions and roles: - Identified breaches lead to action based on supervisory powers, enforcement powers, and sanctioning powers. - Supervisory powers: - Initiative to exercise supervisory powers is in the remit of JSTs. - For SIs these powers are granted to the ECB by Art. 16 SSMR; for LSIs they rest on the transposition of Art. 104 CRD (for Finland in the Act on Credit Institutions). - Enforcement powers: - Aim to compel a bank to comply with prudential requirements; all enforcement actions are initiated by referring the breach to the Enforcement and Sanctions Division (ESA), which assesses the case. - Sanctioning powers: - Used to punish non-compliance; initiated by referral to the ESA, which acts as the ECB’s investigating unit. - ECB direct measures and indirect use of national powers: - Some enforcement measures directly available to the ECB, including periodic penalty payments (Art. 18(7) SSMR) for ongoing breaches of ECB decisions or regulations. - To the extent necessary, pure national enforcement measures not related to transposition of directives are available to the ECB only indirectly (e.g., ECB can instruct the FIN-FSA to impose conditional fines available under national law). - Sanctioning allocations between ECB and NCAs: - For SIs, the ECB has direct sanctioning powers only for pecuniary sanctions on legal persons for breaches of ECB decisions or regulations or directly applicable EU law (e.g., CRR). - For these same breaches, non-pecuniary sanctions and sanctions on natural persons are to be imposed by NCAs upon ECB request. - NCAs impose all types of sanctions upon ECB’s request in case of breaches of national laws transposing the CRD. - For LSIs, sanctioning power rests with the NCA. - Investigation, decision-making and appeal procedures: - Alleged breaches referred are investigated by the ESA Division. - Investigating unit notifies the supervised entity in writing of findings and rights to make submissions, access the ECB’s file, and attend an oral hearing. - After the hearing, if an administrative penalty is still considered, a proposal for a draft decision is submitted to the Supervisory Board. - The Supervisory Board may return the file, adopt the proposal, or adopt a different draft decision; adopted draft is proposed to the Governing Council, which can approve or object. - Two appeal procedures: - Request for review to the Administrative Board of Review (ABoR): ABoR must adopt an opinion on the review no later than two months from receipt of the request; ABoR opinion is not binding and the Supervisory Board then decides whether to propose abrogation, replacement, or amendment of the contested decision. - Legal review by the Court of Justice of the European Union: can verify legality of ECB decisions but not their merit. - Finnish administrative sanctions and time limits: - Administrative sanctions include administrative fines, public warnings, and penalty payments. - Administrative fines: - May be imposed on anyone who willfully or negligently fails to comply with or violates obligations in the FIN-FSA Act or other legislation governing financial markets. - In practice imposed for minor cases, e.g., companies that fail to submit regular reports by a given deadline. - Amounts: - Legal person: no less than EUR 5,000 and no more than EUR 100,000. - Natural person: no less than EUR 500 and no more than EUR 10,000. - Public warnings: - May be issued to supervised entities or other financial market participants that willfully or negligently violate provisions, but only in cases other than offences covered by administrative fine and penalty payment. - Penalty payments: - Administrative sanction for the most serious offences; can be imposed on anyone who willfully or negligently fails to comply with or violates specific provisions or decisions as referred to in the FIN-FSA Act or other legislation. - Amounts and caps: - Penalty payment shall amount to no more than 10 percent of the turnover of the legal person for the year preceding the act or omission, and to no more than EUR 10 million. - Penalty payment imposed on a natural person shall amount to no more than 10 percent of his or her income, according to the latest tax assessment, but to no more than EUR 100,000. - If offences are based on provisions in the Act on Credit Institutions chapter 20 section 1, the penalty payment shall amount to no more than 10 percent of the turnover of the legal person and the penalty payment imposed to a natural person shall amount to no more than EUR 5 million. - Time limits (FIN-FSA Act section 42): - An administrative fine shall not be imposed or a public warning issued if this has not been done within five years of the day on which the act or omission occurred, or for a continued act or omission, within five years of the day on which it terminated. - The FIN-FSA may not impose a penalty payment, or make a proposal for imposition of a penalty payment to the Market Court, if this has not been done within ten years of the day on which the act or omission occurred or, in respect of a continued act or omission, within five years of the day on which it terminated. - Recent practice: - Administrative sanctions imposed in the recent past have focused mainly on market supervision and conduct of business rules. - The FSA has not imposed any sanctions to individual persons (excluding insider register notifications, market supervision related violations and offences). - ECB preparations: - The ECB has initiated the collection of information on powers available in each jurisdiction to create and maintain a regulatory database; the project is on-going and, once finalized, should facilitate the ECB task of preparing to use NCA powers indirectly if needed. ### Nordea transformation and supervisory implications - Planned conversion: - Planned conversion of Nordea Bank Finland (NBF), the largest bank in the country, to a branch of Sweden’s Nordea Bank AB (NBAB). - With conversion, primary supervisor of Nordea’s operations in the branch will shift to the Swedish FSA. - Expected changes: - Nordea indicated it does not expect to change its business model in Finland, but it will shrink its Finnish balance sheet. - The derivative book in NBF, which in 2014 exceeded €100 billion, will be moved to NBAB. - Nordea plans to set up a mortgage lending subsidiary in Finland (necessary due to covered bonds issued in Finland). - Even after reduction in Finnish operations, Nordea is expected to continue to be one of the two largest banks in Finland. - Supervisory challenge: - A key issue for FIN-FSA and the ECB if branchification proceeds will be the role of host supervisors in monitoring and supervising the Nordea branch in cooperation with the home supervisor, the Swedish FSA. - CRD assigns supervisory responsibility to the home supervisor for cross-border branching within the EU, and CRD may not have fully anticipated situations where a branch is systemically important and of critical importance to the host country and its supervisor. *Source: cr1703 - 113.* ### 139. If a branch is considered “significant,” with a deposit market share in excess of ### cr1703 - 139. If a branch is considered “significant,” with a deposit market share in excess of ### Significance of foreign branches and supervisory coordination - If a branch is considered “significant,” with a deposit market share in excess of 2 percent, CRD provides for an increased level of coordination between the host supervisor and the home supervisor. - Under CRD the role of the host supervisor, particularly with respect to information on the health of the parent and supervisory decisions that might affect the branch, is limited. - There is no CRD category for systemically important branches that provide critical financial services to the national economy of the host supervisor; such branches can pose a vulnerability to the host country’s financial stability. ### Host supervisor responsibilities and vulnerabilities - When a foreign branch is one of the largest banks in the host country, the host supervisor should: - Remain current on the financial performance and risks posed to the host economy by both the branch and the parent company. - Fulfill responsibilities to safeguard the domestic banking system by monitoring branch and parent risks. ### Mutual arrangements (MOU) recommended for Finland and ECB - Near-term action: consistent with CRD, Finland and the ECB should enter into mutually-agreed arrangements with home supervisors of branches operating in Finland that are systemically important. - Negotiations are under way to agree on a comprehensive MOU providing FIN-FSA and the ECB with full access to information related to the operations and financial health of the branch. - Recommended MOU contents: - Customized reports related to particular risks of the branch. - Access to annual auditor’s findings for the branch. - Information on the liquidity requirements and positions of the parent bank. ### Supervisory engagement, SEP planning, and resolution - Under the MOU, FIN-FSA/ECB would be actively engaged in supervision of the systemically important branch and its parent through the relevant supervisory college chaired by the home supervisor. - Roles and expectations: - Home supervisor retains responsibility for prudential supervision of the bank; FIN-FSA/ECB involved in risk assessment. - FIN-FSA/ECB should participate in SEP planning for branch activities and have direct interaction with parent bank management and business heads. - FIN-FSA/ECB should be able to assess adequacy of capital and liquidity and be consulted prior to home-supervisor decisions related to liquidity and capital requirements. - Participation in recovery planning covering critical economic activities of the branch, liquidity planning, and the resolution college. - FIN-FSA should have its own strategy to deal with a situation where a systemically important foreign branch is unable to continue providing essential services to Finnish customers. ### On-site inspections, on-the-spot checks, and ongoing communication - MOU should permit FIN-FSA/ECB to: - Participate in on-site inspections of group-level activities relevant to branch operations. - Carry out, upon notification to the home supervisor, on a case-by-case basis, on-the-spot checks and inspections of branch activities. - Hold periodic meetings with branch management to stay informed of performance and planned future activities. ### Nordic cooperation and CRD limitations - Nordic supervisors have a long tradition of collaboration; Sweden (home supervisor) is working with other Nordic supervisors and the ECB to develop a supervisory MOU covering large significant branches to provide host supervisors with enhanced powers regarding access to information and supervisory engagement. - Mutually-agreed arrangements are not binding and may be insufficient in crises; cross-border collaboration can be severely tested even in well-integrated areas. - Recommendation: consider amending CRD to retain free flow of financial services while providing host supervisors with additional authority over systemically-important institutions in close collaboration with home supervisors. - Determination of whether a branch is systemically important (EBA mandate) might be based on ECB metrics for significance: assets in excess of €30 billion and the economic importance of the entity to the specific country or EU economy. ### Main Recommendations (A) - Ensure Finnish legislation grants FIN-FSA all powers needed according to CRD for supervision of LSIs, including powers under art. 104 CRD (range of powers to impose supervisory measures). - Note: Transposition of article 104 CRD in Finland does not ensure FIN-FSA can impose supervisory measures on LSIs under the same conditions set in CRD (examples provided regarding discretionary capital add-on and limitations). - Select future Board members who are experts not part of the government to avoid appearance of government infringement on FSA independence (BCP 2 concerns). - Gradually increase number of supervisory staff to meet ECB demands for FSA staff on JSTs and Inspection teams and for more intense supervision of LSIs. - Strengthen legal protection for FSA officials and staff for actions and omissions in good faith; determine Finnish equivalent of “good faith” and enshrine it in legislation and operational arrangements. - Finalize ongoing negotiations with Sweden on MOUs covering systemically important significant branches to provide greater access to information and enhanced supervisory engagement; organize around core supervisory college for each banking group. - FSA should develop contingency plan for a systemically important foreign branch unable to provide essential services to Finnish customers. - Consider CRD amendments to provide host supervisors additional authority over systemically-important institutions while retaining free flow of services; use ECB significance metrics (assets in excess of €30 billion and economic importance). - Proceed with announced comprehensive review of banks’ internal models and devise sustainable ongoing model monitoring to prevent reductions in model conservatism. - TRIM project planning ongoing; execution expected in the next two years; targeted review of most relevant internal models (especially credit risk) to address lack of comparability and reduced conservatism. - Continue monitoring banks’ diversification of funding sources and analyze crossholding of bonds (in particular covered bonds) within SSM and with Nordic supervisors. - Concerns: heavy reliance on wholesale funding; cross-holdings of covered bonds could produce domino effects if house prices correct; analysis could exploit Securities Holding Statistics database. ### Other Recommendations (B) — selected items - Continue close monitoring of banks’ loan portfolios to verify evolution of renegotiated loans and probe accuracy of asset classification per EBA definitions. - After ‘loan payment holidays’ campaigns ended in Q3/2015, volumes of renegotiated loans have remained at around four times the pre-campaign level. - ECB should update on-site methodology to ensure loan-file samples are selected according to statistically robust criteria to enable extrapolation and benchmarking (e.g., for NPL ratio or ratio of forborne loans over total loans). - Finnish authorities should implement regular data collection of individual loan files to better support credit risk analysis; EA-wide AnaCredit will provide corporate lending data but granular household loan data is lacking and may require legal changes. - Establish regular program to directly verify classification and valuation of fair-valued positions and need for additional valuation adjustments in banks with consistent Level 2 and 3 assets. - Monitor implications of CRD waiver for banks in financial conglomerates holding participations in insurance companies, since capital loss-absorbency may be affected; waiver granted to one Finnish banking group. - Analyze implications of announced draft law restraining municipalities’ tax-raising powers for Municipality Finance and impacts on other banks. - ECB should ensure standardization of supervisory methods does not distract from risk-focused tasks; avoid drift toward excess compliance-based techniques. - ECB should improve communication with banks, including on SREP outcomes; better explanation of data collection purpose and communication of SREP scores (without disclosing methodology) could improve dialogue. - Improve external communication strategy to highlight SSM specificities, especially differences between SIs and LSIs. - Follow EBA opinion on maximum distributable amount and require banks to disclose total capital requirements (Pillar 1 and 2) when relevant for determining maximum distributable amount; weigh potential disadvantages of disclosure in stressed markets. - Consider reporting banks’ capitalization as capitalization indices (ratio of own funds to whole capital requirements) to provide clearer representation of solvency (index >100 percent indicates health). *International Monetary Fund — Finland chapter (excerpt).* ### Appendix I. Summary Analysis of Selected BCPs ### Appendix I. Summary Analysis of Selected BCPs ### Principle 1: Responsibilities, objectives, and powers - An effective system of banking supervision has clear responsibilities and objectives for each authority involved in the supervision of banks and banking groups. - Description of the SSM and Finnish framework: - Responsibilities are shared between the European Central Bank (ECB) and the national competent authorities (NCAs). - The ECB is directly responsible for the supervision of the significant institutions (SIs). - Direct supervision of less significant institutions (LSIs) is in the remit of the NCAs, under the oversight of the ECB. - The FIN-FSA is the Finnish NCA. - The objectives of the ECB as a supervisory authority are stated in the SSM Regulation (Art. 4); the same regulation also specifies the tasks assigned to NCAs and the terms of the cooperation with the ECB. - The Act on the FIN-FSA defines the responsibilities and objectives of the FIN-FSA. - Powers to authorize banks, conduct ongoing supervision, verify banks’ compliance with the laws and undertake timely corrective actions are available to the ECB; applications are to be submitted to the NCA of the Member State where the credit institution is to be established in accordance with the requirements set out in relevant national law. - Identified deficiency: - The way the Capital Requirements Directive (CRD) has been transposed in the Finnish legislation does not ensure that the FIN-FSA can actually impose supervisory measures on the same conditions set in the Directive. ### Principle 2: Independence, accountability, resourcing and legal protection for supervisors - The supervisor possesses operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources, and is accountable for the discharge of its duties and use of its resources. The legal framework for banking supervision includes legal protection for the supervisor. - Key points: - The ECB’s independence is ensured by Article 130 of the Treaty on the Functioning of the European Union and extends to its supervisory tasks, as stated by Article 19 of the SSM Regulation. - The FIN-FSA is administratively subordinated to the Bank of Finland but is independent in its decision making. - The composition of the FIN-FSA Board, with officials from Ministry of Finance and Ministry of Social Affairs serving as board members, creates the appearance of a lack of independence, though there is no evidence of actual government interference. - Processes for the appointment and removal of the heads of both the ECB and the FIN-FSA and of the members of their governing bodies are transparent. - Internal governance: - ECB and SSM: SSM Regulation, ECB Rules of Procedure, Rules of Procedure of the Supervisory Board. - FIN-FSA: FIN-FSA’s Rules of Procedure. - Financing and resources: - ECB resources are financed via a supervisory fee to be borne by the entities subject to the ECB’s supervision; budgetary authority vested in its Governing Council. - Original headcount for ECB supervisory functions proved insufficient; in September 2015 the Governing Council took the decision to augment the SSM-related headcount over the next two years. - ECB staff are immune from legal proceedings in respect of acts performed by them in their official capacity, including their words spoken or written. - FIN-FSA operations financed through fees collected from the supervised entities and a contribution from the Bank of Finland (5 percent). - A working group, led by the Ministry of Finance, assesses the need for updating the law on the financing of the FIN-FSA, also in view of the implications, for the FIN-FSA fee collection, of the upcoming transformation of Nordea Bank Finland into a branch of the Swedish parent. - FIN-FSA headcount has been stable and somewhat decreasing for several years and it is expected to decrease slightly in the next years; this is proving to be a constraint on FSA efforts to adapt to the more intense, intrusive and resource-intensive supervisory approach of the SSM on SIs and to reinforce supervisory intensity on LSIs, as well as increasing demands on macroprudential policy analysis, contingency planning and crisis management. - Legal protection gap: - Finnish financial sector legislation does not include clauses to provide officials and staff of the FIN-FSA legal protection for actions and omission in good faith in the exercise of their official duties. ### Principle 8: Supervisory approach - An effective system of banking supervision requires a forward-looking assessment of the risk profile of individual banks and groups; identification and addressing of systemic risks; framework for early intervention; plans for orderly resolution in partnership with relevant authorities. - Description and observations: - EU supervisory approach outlined in the CRD and detailed in EBA regulations and guidelines, notably Guidelines on common procedures and methodologies for the supervisory review and evaluation process (SREP). - Approach applied proportionately depending on nature, scale, and complexity of activities; applied on consolidated and solo basis with emphasis on consolidated perspective. - In the SSM the SREP assesses an institution’s viability at a 12-month horizon, in the medium term (3 to 5 years), and over the cycle, relying on a range of backward and forward-looking, quantitative and qualitative information, such as the outcome of stress tests. - The SREP on Finnish LSIs is largely consistent with the EBA guidelines and gradually converging to the SSM approach. - ECB advantage: - Performing the SREP assessment simultaneously for all institutions under direct supervision puts the ECB in a favorable position to identify common trends; horizontal analysis is integral to the SSM SREP methodology. - Macro expertise: - FIN-FSA has its own expert focusing on the macro-economic environment but relies extensively on the macroeconomic expertise of the Bank of Finland. - Crisis management: - SSM crisis management framework covers phases from preparatory activities to involvement in decisions on resolution; main decision-makers during resolution are the Single Resolution Board (SRB) and national resolution authorities (NRAs). - SSM plays an advisory role and cooperates with NRAs/SRB on follow-up actions. - In Finland the NRA is the Finnish Financial Stability Authority (FFSA). - Methodology risk: - ECB supervisory manual methodologies rest on a high degree of standardization and formalism (e.g., checklists); while standardization is essential, there is a risk of drift towards an excess of compliance-based techniques and distraction from more risk-focused tasks. ### Principle 9: Supervisory techniques and tools - The supervisor uses an appropriate range of techniques and tools and deploys resources proportionately. - Description: - In the SSM the mix between on-site and off-site supervision for a given SI results from the supervisory examination program (SEP). - Banks categorized by systemic footprint (six ‘clusters') and SREP scores (on a 1–4 scale); SEP identifies minimum engagement levels and core activities risk by risk. - FIN-FSA processes: - Bi-annual planning process for on-site inspections and an annual planning process for off-site supervision. - Plans reflect supervisory findings identified during supervisory activities. ### Principle 11: Corrective and sanctioning powers of supervisors - The supervisor acts early to address unsafe and unsound practices and has an adequate range of supervisory tools, including revocation of a banking license. - Description: - According to the SSM Supervisory Manual, the ECB may identify the need for immediate supervisory measures to counteract negative developments at a SI during on-going or on-site supervisory activities. - SSM enforcement and sanctioning is based on a combination of powers assigned to the ECB (e.g., power to withdraw an authorization) or the NCAs, with the latter not being fully harmonized. - Where the ECB lacks powers to directly impose an enforcement measure or sanction, it can request or instruct the NCAs to act, based on the powers available to them; this complex arrangement has not been put to the test so far in Finland. - ECB has initiated collection of information on powers available in each jurisdiction to create and maintain a regulatory database; project is ongoing. - For LSIs, when supervisory concerns arise the FSA engages the bank’s management or, where appropriate, the bank’s Board, informally or formally. - Formal decisions or measures for LSIs are taken by either the DG or the board of the FIN-FSA. - Examples of formal administrative actions: conditional fines, restrictions of the authorized business activity or management activities, appointment of an external attorney to supervise the activities of an authorized supervised entity, prohibition of the execution of a decision or revocation of the execution of the decision. ### Principle 16: Capital adequacy - The supervisor sets prudent and appropriate capital adequacy requirements reflecting risks; components of capital defined with loss-absorption capacity; at least for internationally active banks, requirements not less than Basel standards. - Description and assessments: - The CRD and the Capital Requirements Regulation (CRR) implement the Basel capital standards in the EU; complemented by EBA Regulatory Technical Standards (RTS) on Own Funds; apply to all banks in the EU. - Basel Committee RCAP 2014 assessment of EU implementation: - Materially Non-Compliant overall. - Compliant: scope of application, transitional arrangements, capital buffers, internal models approach for market risk, operational risk, supervisory review process and disclosure requirements. - Largely Compliant: definition of capital, standardized approach for credit risk, securitization framework, standardized approach for market risk. - Materially Non-Compliant: IRB approach for credit risk. - Non-Compliant: counterparty credit risk framework. - ECB actions: - Initiated stock-take of available national discretions, collect information on how discretions exercised in each jurisdiction, identify discretions that could be exercised directly by the ECB to enhance harmonization. - Example national discretion: - Member states option to allow banking groups that are part of a financial conglomerate not to deduct participation in insurance companies without demonstrating no lower level of calculated capital (as required by Basel). - Finland has exercised this option and granted the waiver to a bank. ### Principle 17: Credit risk - Supervisor ensures banks have adequate credit risk management covering full credit lifecycle. - Description: - CRD established requirements on banks’ credit risk management. - EBA guidelines set supervisor expectations for internal credit risk processes. - ECB supervisory manual provides investigative suggestions for on-site inspections covering the whole lending lifecycle. - Credit risk is one of the sub-elements of the Capital element in the RAS. - Finnish requirements: - Banks must comply with FIN-FSA Standard 4.4a - Management of credit risk, including provisions on credit risk strategy and credit risk management procedures. - Noted gap: - No requirement in law/regulation or supervisory methodology for a bank’s Board or senior management to approve credit risk exposures exceeding a certain amount or percentage of a bank’s capital or especially risky or otherwise not in line with the mainstream of the bank’s activities (EC 6 of this principle). ### Principle 18: Problem assets, provisions and reserves - Supervisor determines banks have adequate policies and processes for early identification and management of problem assets, and maintenance of adequate provisions and reserves. - Description: - EBA Guidelines require supervisors to assess sound, clearly formulated and documented credit risk strategy approved by the management body; appropriate organizational framework; appropriate policies for identification, management, measurement and control of credit risk. - FIN-FSA Standard 4.4a – Management of credit risk contains similar requirements. - EBA guidelines ask supervisors to assess overall credit quality at portfolio level and categories “performing,” “non-performing,” and “forborne”; supervisors recommended to use EBA definitions. - Recent Finnish inspections: - Non-statistical samples of loan files prevented use of extrapolation techniques to calculate expected convergence levels for NPL ratios or forborne loan ratios. - Data limitation: - Lack of granular data on household loans in Finland limits supervisor’s ability to closely monitor phenomena (e.g., explosion of renegotiated loans). - Power limitation: - Limits in implementation of supervisory powers set forth in the CRD in Finland prevent the FIN-FSA from imposing an adjustment to provisioning for prudential purposes. ### Principle 22: Market risk - Supervisor determines banks have adequate market risk management processes, including for market liquidity deterioration. - Description: - CRD requires competent authorities to ensure policies and processes for identification, measurement and management of material sources and effects of market risks and that internal capital is adequate for material market risks not subject to own funds requirement. - EBA SREP guidelines specify market risk management elements to be assessed in SREP: market risk strategies and appetites; organizational frameworks; policies and procedures; risk identification, measurement, monitoring and reporting; internal control framework. - ECB supervisory manual provides guidance/questions to verify adequacy and soundness of market risk management over governance, risk appetite, risk management and internal controls, and internal audit. - Market risk is a sub-element of the Capital element in the RAS. - Finnish LSIs: - Must meet requirements of standard on Management of market risk (4.4c), including core principles and provisions on establishment and maintenance of these functions. - Currently only two LSI have trading books; currency risks in the banking book are minor for LSIs. ### Principle 23: Interest rate risk in the banking book - Supervisor determines banks have adequate systems to manage interest rate risk in the banking book (IRRBB). - Description: - CRD specifies duties for management body to approve and periodically review strategies and policies for taking up, managing, monitoring and mitigating risks; addresses need for banks to implement systems to identify, evaluate and manage interest rate risk affecting non-trading activities. - EBA Guidelines on management of IRRBB provide guidance on methodology and measurement assumptions, stress testing and scenarios, governance, mitigation through internal capital, model validation. - EBA SREP guidelines set elements supervisors should cover when assessing IRRBB management: strategies and appetites; organizational frameworks; policies and procedures; risk identification, measurement, monitoring and reporting; internal control framework. - IRRBB assessment covered in ECB supervisory manual and is a sub-element of Capital element in the RAS. - Finland: - LSIs are required to comply with the EBA Guidelines on the management of interest rate risk arising from non-trading activities. ### Principle 24: Liquidity risk - The supervisor sets prudent and appropriate liquidity requirements and ensures banks have strategies for prudent liquidity management over appropriate time horizons. - Description and vulnerabilities: - CRR introduced the Liquidity Coverage Ratio (LCR) in the EU; in force since October 2015. - Commission delegated regulation (EU) 2015/61 supplements CRR with regard to LCR and provides details. - The requirement follows BCBS LCR broadly but with divergences, mostly less conservative than BCBS, which improve the ratios. - Relevant divergence for Finnish banks: particularly generous eligibility criteria for covered bonds in the Highly Liquid Assets Buffer for the LCR. - Covered bond concentration: - For Finnish banks, covered bonds average around 30 percent of their liquid assets, representing a potential vulnerability. - In certain cases concentration on a single issuer can be even above 95 percent. - High level of covered bonds cross-holdings among banks in the Nordic area could become a source of contagion if a major correction in house prices undermines covered bond market confidence. - SSM methodology requires supervisors to verify banks establish and regularly review funding strategies and processes for measurement and monitoring of funding requirements and effective management of funding risk. - ECB Supervisory manual assesses institution strategy comprehensively for compliance with liquidity requirements, including liquidity risk strategy definition, approval by management board, documentation, implementation, communication, and integration within overall risk appetite framework. - FIN-FSA standard ‘Management of liquidity risk’ (4.4d) includes recommendations, application guidelines and examples; implemented based on proportionality principle. Standard covers: liquidity strategy, liquidity risk management, control and procedures, liquidity buffer, stress testing and scenarios, contingency funding plan, and disclosure of information. *Source: Appendix I. Summary Analysis of Selected BCPs (cr1703 - Appendix I. Summary Analysis of Selected BCPs).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1703.pdf_