## FINLAND — Financial System Stability Assessment Update (FSAP Update), August 5, 2010

## Source details

**Canonical URL:** [FINLAND — Financial System Stability Assessment Update (FSAP Update), August 5, 2010](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10275.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10275.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10275.pdf.json)

---

### Executive summary — systemic findings and vulnerabilities
- Despite a sharp economic downturn in 2009, the Finnish financial sector has weathered the global financial crisis.  
- GDP fell by 7¾ percent in 2009; a modest recovery of 1.2 percent is projected for 2010 (up from -7.8 percent in 2009).  
- Financial sector highly integrated into the Nordic financial system; negligible exposure to toxic assets.  
- Banks continued to report positive (albeit lower) profits and loan growth during the crisis; nonperforming loans (NPLs) increased slightly to 0.7 percent of gross loans at-end-2009.  
- Capital adequacy levels are well above minimum requirements; bank capital buffers on average appear sufficient to withstand a range of stress scenarios.  
- Insurance companies and pension funds were relatively more affected by capital markets turbulence but benefited from a recovery in equity markets and the long-term nature of their liabilities.  
- Key bank vulnerabilities warranting close monitoring:
  - Credit risk embedded in variable rate lending that leaves borrowers exposed to interest rate normalization.
  - Reliance on wholesale funding, with loan-to-deposit ratio reported as well above 100 percent, exposing banks to liquidity risk and higher funding costs.
  - Pressure on profitability from intensifying competition for deposits and low interest rates on new loans.
- Contagion risks are significant because of high concentration and strong domestic and cross-border interlinkages.
- Upcoming international regulatory changes (including Basel liquidity proposals and EU cross-border supervisory/crisis management reforms) will have significant implications given the system’s foreign ownership and concentration.

### Stress resilience and liquidity concerns
- Direct interest rate risk limited for banks (loans mostly at floating rates); indirect borrower stress from rate rises could increase credit losses.  
- Base rate decline: 5 percent in January 2009 → 1.25 percent in January 2010; reversal could hurt household and housing companies’ ability to repay mortgages. Loan insurance and interest rate caps would partly mitigate this effect.  
- Wholesale funding costs may be affected by Euro area sovereign debt stress and by forthcoming tighter liquidity risk regulations; an increase in policy rates and withdrawal of ECB liquidity support might translate into higher market funding costs.  
- Stress tests indicate banks can absorb sizeable shocks, but liquidity and credit risks require continuous monitoring and enhanced top-down stress testing capabilities.

### Safety net and crisis management issues
- Current bank resolution framework is limited: deposit institutions are subject to ordinary liquidation proceedings with very limited least-cost resolution tools; this constrains effective and prompt corrective actions.  
- Cross-border resolution and burden-sharing clarity is lacking given the high concentration of multinational banks.  
- Deposit Guarantee Fund (DGF): assets under management EUR 629 million at end-2009 (corresponding to 1.1 percent of the system’s deposits by households and nonfinancial corporations); would benefit from an evaluation using the Core Principles for Effective Deposit Insurance Systems to guide operational resource adequacy and potential reforms.

### Supervisory strengths and shortcomings
- Banking supervision robust and closely follows relevant EU Directives and the Basel Core Principles for Effective Banking Supervision (BCP). FIN-FSA has implemented 2001 FSAP recommendations.  
- Remaining supervisory challenges:
  - Weakness in FIN-FSA’s ability to impose administrative sanctions beyond securities markets related scope; maximum fines/penalties are limited.
  - Home-host cooperation and information sharing need strengthening to address risks from large foreign banks and potential subsidiary-to-branch conversions.
  - Further integration of banking and insurance supervision procedures desirable to improve consolidated risk assessment of financial conglomerates.
  - Increased supervisory focus on liquidity risk recommended, using forthcoming FIN-FSA liquidity standards as a catalyst.

### Financial system structure and concentration
- Total banking assets around EUR 350 billion at end-2009 (equivalent to about 200 percent of GDP), up from 110 percent of GDP in 2003.
- Assets of majority foreign-owned banks amount to around 70 percent of all banking system assets.
- Number of credit institutions: 349; system concentrated:
  - Four banking groups account for over 90 percent of total assets.
  - The largest two account for three quarters of lending.
  - Cooperative banks: 263 (most part of OP Pohjola group).
  - Savings banks: 35.
- Financial conglomerates prominent with strong Nordic cross-border linkages; most groups operating in Finland comprise banks, insurance, securities, and other financial services companies.
- Sampo Group increased its holdings in Nordea to over 20 percent, making Nordea Group (Sweden) Sampo’s associated company; Nordea owns the largest bank in Finland.

### Macroeconomic developments and outlook (implications for financial sector)
- Real GDP fell by 7.8 percent in 2009 as exports collapsed.  
- General government overall deficit in 2009: -2.4 percent of GDP (first deficit since 1997); discretionary stimulus of 1.7 percent of GDP adopted in early 2009.  
- Gross debt ratio: 44 percent of GDP at end-2009.  
- Automatic stabilizers imply a large budget relaxation, estimated at 3-4 percent of GDP.  
- 2010 projections and near-term expectations:
  - Economic activity projected to rebound somewhat in 2010, but unemployment expected to approach 9 percent in 2010.
  - Private consumption expected to remain weak; investment expected to lag.
  - Inflation likely to decline given the sizable output gap.
  - Interest rates likely to remain low for some time to support recovery and maintain financial stability; in the medium term interest rates expected to normalize.

### Household and corporate balance sheets — vulnerabilities
- Household sector:
  - Financial assets largely recovered to pre-crisis levels due to equity market rebound in 2009.
  - Household indebtedness: 110 percent of disposable income in 2008.
  - Proportion of loans with floating interest rates (in particular mortgage loans) is over 95 percent.
  - Rising unemployment increases latent credit risk; mitigants include limited mortgage insurance for unemployment/illness and interest rate caps on floating rate mortgages.
- Corporate sector:
  - Ratio of debt to total assets increased from less than 23 percent in 2007: Q3 to over 40 percent in 2009: Q1.
  - Corporate debt outstanding: EUR 18,637 million (2009); new corporate bond issues issued in Finland: EUR 1,075 million (2009).
  - Finnvera loans to SMEs: EUR 852 million (2007) and EUR 1,031 million (2009).
  - Rising payment defaults and bankruptcies expected to rise further; SMEs most affected by tighter collateral requirements.

### Banking sector soundness and resilience
- Competition and efficiency:
  - Despite concentration, banking sector is highly competitive and efficient by international standards.
  - Net interest margins narrowed significantly and are lower than in most neighboring countries.
- Asset quality and loan performance:
  - Exposure to toxic assets minimal.
  - NPL rate increased to 0.7 percent in 2009 from 0.5 percent in 2008.
- Capital adequacy:
  - Tier 1 capital ratio declined slightly in 2008 then improved in 2009 due to rights issues, partial shift toward less risky assets, and expiration of transitional additional capital requirements related to Basel II.
  - Smaller cooperative and savings banks have even larger capital buffers.
- Earnings and margins:
  - Low interest rates depressed earnings markedly; net interest income decreased.
  - Larger banks offset decline in net interest income by increasing non-interest income.
- Liquidity and funding:
  - Banks dependent on wholesale funding—loan-to-deposit ratio reported well above 100 percent; liquidity ratios lower than in neighboring countries.
  - Main banking groups have good credit ratings (Nordea Bank Finland Group and OP Pohjola Group Aa2; Sampo Bank Group and Aktia A1).

### Funding, liquidity, and market access (stress testing highlights)
- Liquidity ratios (cash and trading assets to total assets) lower than in neighboring countries; liquidity buffers low for some banks under narrow definitions but broader definitions (including securities eligible for ECB refinancing) reduce perceived risk.
- Stress test key findings:
  - Credit risk is the key source of risk; capital adequacy would remain above the mandatory level under most stress scenarios given large capital buffers.
  - Extreme scenarios (e.g., 1990s crisis default rates or massive mortgage defaults) could bring capital adequacy below regulatory norm.
  - Concentration risk significant; some large banks act as liquidity hubs and would be contagion channels.
  - Market risk modest for system as a whole; single-factor shocks to equity/exchange rates have relatively small impact.
  - Residential real estate shocks have minor effects given historically low mortgage default rates and limited direct lending to commercial property.
  - Interest rate risk modest in direct effect but variable-rate lending means borrower debt service could increase sharply when rates normalize.
- Banks indicated clients’ debt-service capacity stress-tested to interest rate levels of 6 percent; current debt service-to-income ratios are quite low.
- FIN-FSA advised to monitor mortgage lending practices (including pricing and LTV ratios) and ensure banks follow guidance on LTV (maximum of 90 percent).

### Selected stress test results (end-December 2009 data) — preserved exactly where provided
- Pre-shock CAR (end-December 2009) 12.314.525.8
- Credit Risk
  - 1 Increase in NPLs by 700 percent 9.411.825.00
  - 2 Increase in NPLs to 13 percent (1990s banking crisis levels)2.47.024.631.6
  - 3 30 percent of loans to commercial real estate turning into NPLs11.213.025.60
  - 5 30 percent of mortgage loans turning into NPLs5.810.625.824.5
- Interest Rate Risk - Effect on Net Interest Income
  - 1 Parallel upward shift of the interest rate by 200 basis points13.515.329.90
  - 2 Parallel downward shift of the interest rate by 100 basis points11.514.123.80
- Exposure Concentration
  - 1 Default of banks' largest 10 exposures0.0...6.9100
- Asset Price Risk
  - 1 Equity prices decline by 70 percent11.414.225.80
  - 2 Residential real estate prices decline by 30 percent11.614.025.80
- Multi-factor shock
  - 1 Increase in NPLs by 700 percent, and decline in interest rates by 100 percent, equity prices by 70 percent and commercial and residential estate prices by 30 percent 4.610.424.91.1
- Scenario Analysis (Cumulative to 2011)
  - 1 Double dip14.113.514.4
  - 2 Global financial shock13.412.412.5
  - 3 Loss of confidence13.112.011.7

### Insurance and pension funds
- Insurance companies and pension funds more sensitive to market risk but maintain acceptable solvency levels except for some life insurance companies, which would become insolvent under the most extreme equity price scenario due to a large equity portfolio (around 20 percent of assets).  
- Interest rate shocks up to 400 basis points, equity price decreases up to 70 percent, and real estate and exchange rate shocks (up to 30 percent) were considered.

### Market infrastructure developments
- Payment systems legal framework updated: Payment Services Act and Payment Institution Act entered into force on May 1, 2010.  
- BOF responsible for oversight as member of the ESCB.  
- Major payment systems: BOF TARGET2 component system; POPS inter-bank system; PMJ system for retail payments.  
- In December 2008 a license for payment transmission was granted to ACH Finland Plc (ACHF).  
- Replacement of POPS and PMJ with the Euro Banking Association STEP2 system under consideration.  
- Securities settlement: Euroclear Finland (EFi) migration to Euroclear’s Single Platform in 2012–13 planned; EFi performs APK settlement systems for equity (OM) and non equity (RM).  
- Mid-November 2009: mandatory CCP-clearing introduced for large and mid-cap cash equities traded on Nasdaq OMX Helsinki; CCP-services provided by the European Multilateral Clearing Facility (EMCF).  
- BOF and FIN-FSA signed a multilateral MOU with Dutch, Danish, Icelandic and Swedish counterparties on supervision and oversight of EMCF.

### Bank resolution framework — domestic and cross-border recommendations
- Cross-border resolution: need effective framework to complement cross-border supervision; recent MOUs with Nordic and Baltic countries strengthen regional crisis readiness; effectiveness of agreements needs periodic testing and review, especially on burden sharing.  
- Domestic resolution: absence of a specific insolvency framework for banks means deposit institutions subject to ordinary liquidation proceedings; key recommendations include establishing a special resolution regime with features such as:
  - authority for mandatory debt restructuring;
  - purchase and assumption transactions;
  - use of bridge banks;
  - temporary public ownership;
  - merger with other banks;
  - liquidation.
- Regime should enable overriding shareholder rights when public interest requires and provide mechanisms for burden sharing across debt holders rather than blanket bail-outs. Constitutional constraints to set up a bank insolvency regime may need to be overcome.

### Deposit Insurance Fund (DGF) — key facts and reforms
- DGF mandated by law, managed by contributing banks, pre-funded and collects risk-based premiums.  
- Assets under management: EUR 629 million at end-2009 (corresponding to 1.1 percent of the system’s deposits by households and nonfinancial corporation).  
- Coverage changes: increased from EUR 25,000 to EUR 50,000 in 2008; by end-2010 it will be further increased to EUR 100,000.  
- Payout period: current payout period 3 months, extendable up to 3 times to 1 year; authorities intend to shorten substantially to 20 working days, extendable 10 more days (falls short of EU proposals for payouts within 1 week).  
- Recommendation: evaluate DGF against the Core Principles for Effective Deposit Insurance Systems once assessment methodology is available.

### Emergency Liquidity Assistance (ELA)
- Existing ELA framework appears solid but may need additional clarity on cross-border access to ELA.  
- First line of defense is the ECB refinancing framework, which has shown flexibility to meet even a systemic liquidity crisis.  
- BOF contingency arrangements: contingency plan to provide short-term collateralized financing in case a solvent systemically important supervised entity faces a liquidity crisis; collaboration with FIN-FSA on eligibility and adequacy of collateral.  
- Arrangements with other central banks exist through crisis management MOUs but do not cover certain operational cross-border dimensions, e.g., explicit listing of possible collateral from another jurisdiction eligible for ELA.

### Key quantitative points and indicators (preserved exactly)
- GDP: -7¾ percent in 2009; projected 1.2 percent for 2010 (table notes -7.8 percent in 2009 also reported).  
- Interest rate (base rate): 5 percent in January 2009 → 1.25 percent in January 2010.  
- NPLs: 0.7 percent of gross loans at-end-2009.  
- Corporate credit: declined by 3.5 percent in 2009.  
- Loan-to-deposit ratio: reported to be well above 100 percent.  
- Total banking assets at end-2009: EUR 349,109 million.  
- Banking groups assets as percent of GDP: 204.2 (2009).  
- Banking groups: Number — 15 in 2009; Domestic-majority owned — 11; Foreign-majority owned — 4; Branches of foreign banks — 15.  
- Stock market capitalization: EUR 140,931 million (2009) — equivalent to 82.4 percent of GDP.  
- Real GDP growth: -7.8 (2009) and projected 1.2 (2010).  
- Unemployment rate: 8.3 (2009) and 8.8 (2010 projected).  
- Consumer price inflation (harmonized): 1.6 (2009) and 1.4 (2010 projected).  
- General government balance: -2.4 percent of GDP (2009) and projected -4.1 percent of GDP (2010).  
- Gross debt (EMU definition): 43.8 percent of GDP (2008) and 49.7 percent of GDP (2010 projected).  
- Household indebtedness: 110 percent of disposable income in 2008.  
- Finnvera loans to SMEs: EUR 852 million (2007) and EUR 1,031 million (2009).  
- NPL rate: 0.7 percent in 2009.

### Policy recommendations (selected, with timelines as presented)
- Monitor bank mortgage pricing practices and household debt service capacity closely; increase efforts to compile mortgage portfolio information, including loan-to-value (LTV) ratios. Frequency: annually. Timeline: 6 months. ¶19
- Enhance the top-down stress testing framework by (i) modeling macro-financial linkages on a bank-by-bank basis; (ii) further integrating bank and sectoral data; (iii) incorporating financial conglomerate dimension; and (iv) improving synergies between the Bank of Finland’s Research and Financial Stability Divisions and FIN-FSA. Exercise can be conducted quarterly. Timeline: 6-12 months. ¶23
- Make available quarterly core financial soundness indicators using the data dissemination system already in place. Timeline: 3 months. ¶23
- Enhance the framework to assess systemic risk by: (i) using more detailed information on cross-border exposures; (ii) including all nonbank elements of the financial sector and cross-border linkages; (iii) establishing cross-border cooperation on systemic risk assessment with other authorities; and (iv) integrating the framework into supervisory tools. Timeline: 6-12 months. ¶30
- Set up a bank-specific resolution regime to enhance cost-effectiveness and speed of bank resolution. Timeline: 1-2 years. ¶47
- Use Core Principles for Effective Deposit Insurance Systems to evaluate and assure operational resources of the Deposit Insurance Scheme commensurate with needs. Timeline: 6-12 months. ¶49
- Improve FIN-FSA’s supervisory powers to impose administrative fines and/or penalty payments beyond the current securities markets related scope; increase the maximum amount of such fines and penalties. Timeline: 6–12 months. ¶34
- Increase the effectiveness of cross-border supervision, including information sharing with home supervisors regarding foreign branches’ activity. Timeline: 6 months. ¶29
- Increase the focus on liquidity risk, using the forthcoming FIN-FSA liquidity standard as a catalyst for detailed analysis of supervised institutions’ funding profiles. Timeline: 6 months. ¶36
- Further integrate procedures and practices of banking and insurance supervision to enhance FIN-FSA’s consolidated analysis of complex financial groups active in Finland. Timeline: 1–2 years. ¶35

### Risk Assessment Matrix — selected threats and impacts (preserved exactly)
- A.1 Slow real sector recovery — Likelihood: Medium. Impact: High. Considerations: Finland’s export structure (information and communication technology and capital goods) and high wage/unit labor cost pressures reduce competitiveness; consumption and investment likely weak; slow recovery would raise household and SME loan losses. ¶A.1
- A.2 Higher funding costs — Likelihood: Medium. Impact: High. Considerations: Need to readjust funding maturities to meet new liquidity regulation; reliance on wholesale funding and competitive deposit markets imply increased profitability pressure. ¶A.2
- A.3 CRE exposure — Likelihood: Medium. Impact: Low. Considerations: Rising vacancy rates and falling rents signal potential misalignment; overall bank exposure to CRE appears limited. ¶A.3
- A.4 Declining residential property values — Likelihood: Medium. Impact: Low. Considerations: Housing prices fell in 2008 then recovered on low rates; declining collateral values could raise provisions, though mortgage loan loss rates are historically low. ¶A.4
- B.1 Subsidiary-to-branch conversions (cross-border supervision fallout) — Likelihood: Medium. Impact: High. Considerations: Conversion would limit FIN-FSA supervisory effectiveness for large banks. ¶B.1
- B.2 Lack of effective resolution framework — Likelihood: Low. Impact: High. Considerations: Low probability given current system robustness, but current liquidation-based approach limits least-cost, prompt resolution and cross-border burden-sharing clarity. ¶B.2

*International Monetary Fund — Financial System Stability Assessment Update for Finland, prepared by the Monetary and Capital Markets and European Departments; approved August 5, 2010.*

### 2010. The views expressed in this document are those of the staff team and do not necessarily reflect

### FINLAND — Financial System Stability Assessment Update (FSAP Update), August 5, 2010

### Executive summary — systemic findings and vulnerabilities
- Despite a sharp economic downturn in 2009, the Finnish financial sector has weathered the global financial crisis.  
- GDP fell by 7¾ percent in 2009; a modest recovery of 1.2 percent is projected for 2010 (up from -7.8 percent in 2009).  
- The financial sector is highly integrated into the Nordic financial system and had negligible exposure to toxic assets.  
- Banks continued to report positive (albeit lower) profits and loan growth during the crisis; nonperforming loans (NPLs) increased slightly to 0.7 percent of gross loans at-end-2009 but remain low.  
- Capital adequacy levels are well above minimum requirements; bank capital buffers on average appear sufficient to withstand a range of stress scenarios.  
- Insurance companies and pension funds were relatively more affected by capital markets turbulence but benefited from a recovery in equity markets and the long-term nature of their liabilities.  
- Key bank vulnerabilities warranting close monitoring:
  - Credit risk embedded in variable rate lending that leaves borrowers exposed to interest rate normalization.
  - Reliance on wholesale funding, with loan-to-deposit ratio reported as well above 100 percent, exposing banks to liquidity risk and higher funding costs.
  - Pressure on profitability from intensifying competition for deposits and low interest rates on new loans.
- Contagion risks are significant because of high concentration and strong domestic and cross-border interlinkages.
- Upcoming international regulatory changes (including Basel liquidity proposals and EU cross-border supervisory/crisis management reforms) will have significant implications given the system’s foreign ownership and concentration.

### Stress resilience and liquidity concerns
- Banks’ exposures to direct interest rate risk are limited (loans mostly at floating rates), but indirect borrower stress from rate rises could increase credit losses.  
- The sharp reduction in interest rates from 5 percent in January 2009 to 1.25 percent in January 2010 eased household debt service but a reversal could hurt household and housing companies’ ability to repay mortgages. The use of loan insurance and interest rate caps would partly mitigate this effect.  
- Wholesale funding costs may be affected by Euro area sovereign debt stress and by the forthcoming tighter liquidity risk regulations; an increase in policy rates and withdrawal of ECB liquidity support might translate into higher market funding costs.  
- Stress tests indicate banks can absorb sizeable shocks, but liquidity and credit risks require continuous monitoring and enhanced top-down stress testing capabilities.

### Safety net and crisis management issues
- The current bank resolution framework is limited: deposit institutions are subject to ordinary liquidation proceedings with very limited least-cost resolution tools. This constrains effective and prompt corrective actions.  
- Cross-border resolution and burden-sharing clarity is lacking given the high concentration of multinational banks.  
- The Deposit Guarantee Fund (DGF) would benefit from an evaluation using the Core Principles for Effective Deposit Insurance Systems to guide operational resource adequacy and potential reforms.

### Supervisory strengths and shortcomings
- Banking supervision is robust and closely follows relevant EU Directives and the Basel Core Principles for Effective Banking Supervision (BCP). FIN-FSA has implemented 2001 FSAP recommendations.  
- Remaining supervisory challenges:
  - Weakness in FIN-FSA’s ability to impose administrative sanctions beyond securities markets related scope; maximum fines/penalties are limited.
  - Home-host cooperation and information sharing need strengthening to address risks from large foreign banks and potential subsidiary-to-branch conversions.
  - Further integration of banking and insurance supervision procedures is desirable to improve consolidated risk assessment of financial conglomerates.
  - Increased supervisory focus on liquidity risk is recommended, using forthcoming FIN-FSA liquidity standards as a catalyst.

### Key quantitative points and indicators (as reported)
- GDP: -7¾ percent in 2009; projected 1.2 percent for 2010 (table notes -7.8 percent in 2009 also reported).  
- Interest rate (base rate): 5 percent in January 2009 → 1.25 percent in January 2010.  
- Nonperforming loans (NPLs): 0.7 percent of gross loans at-end-2009.  
- Corporate credit: declined by 3.5 percent in 2009.  
- Loan-to-deposit ratio: reported to be well above 100 percent (indicative reliance on wholesale funding).

### Policy recommendations (selected, with timelines as presented)
- Monitor bank mortgage pricing practices and household debt service capacity closely; increase efforts to compile mortgage portfolio information, including loan-to-value (LTV) ratios. Frequency: annually. Timeline: 6 months. ¶19
- Enhance the top-down stress testing framework by (i) modeling macro-financial linkages on a bank-by-bank basis; (ii) further integrating bank and sectoral data; (iii) incorporating financial conglomerate dimension; and (iv) improving synergies between the Bank of Finland’s Research and Financial Stability Divisions and FIN-FSA. Exercise can be conducted quarterly. Timeline: 6-12 months. ¶23
- Make available quarterly core financial soundness indicators using the data dissemination system already in place. Timeline: 3 months. ¶23
- Enhance the framework to assess systemic risk by: (i) using more detailed information on cross-border exposures; (ii) including all nonbank elements of the financial sector and cross-border linkages; (iii) establishing cross-border cooperation on systemic risk assessment with other authorities; and (iv) integrating the framework into supervisory tools. Timeline: 6-12 months. ¶30
- Set up a bank-specific resolution regime to enhance cost-effectiveness and speed of bank resolution. Timeline: 1-2 years. ¶47
- Use Core Principles for Effective Deposit Insurance Systems to evaluate and assure operational resources of the Deposit Insurance Scheme commensurate with needs. Timeline: 6-12 months. ¶49
- Improve FIN-FSA’s supervisory powers to impose administrative fines and/or penalty payments beyond the current securities markets related scope; increase the maximum amount of such fines and penalties. Timeline: 6–12 months. ¶34
- Increase the effectiveness of cross-border supervision, including information sharing with home supervisors regarding foreign branches’ activity. Timeline: 6 months. ¶29
- Increase the focus on liquidity risk, using the forthcoming FIN-FSA liquidity standard as a catalyst for detailed analysis of supervised institutions’ funding profiles. Timeline: 6 months. ¶36
- Further integrate procedures and practices of banking and insurance supervision to enhance FIN-FSA’s consolidated analysis of complex financial groups active in Finland. Timeline: 1–2 years. ¶35

### Risk Assessment Matrix — selected threats and impacts
- A.1 Slow real sector recovery — Likelihood: Medium. Impact: High. Considerations: Finland’s export structure (information and communication technology and capital goods) and high wage/unit labor cost pressures reduce competitiveness; consumption and investment likely weak; slow recovery would raise household and SME loan losses. ¶A.1
- A.2 Higher funding costs — Likelihood: Medium. Impact: High. Considerations: Need to readjust funding maturities to meet new liquidity regulation; reliance on wholesale funding and competitive deposit markets imply increased profitability pressure. ¶A.2
- A.3 CRE exposure — Likelihood: Medium. Impact: Low. Considerations: Rising vacancy rates and falling rents signal potential misalignment; overall bank exposure to CRE appears limited. ¶A.3
- A.4 Declining residential property values — Likelihood: Medium. Impact: Low. Considerations: Housing prices fell in 2008 then recovered on low rates; declining collateral values could raise provisions, though mortgage loan loss rates are historically low. ¶A.4
- B.1 Subsidiary-to-branch conversions (cross-border supervision fallout) — Likelihood: Medium. Impact: High. Considerations: Conversion would limit FIN-FSA supervisory effectiveness for large banks. ¶B.1
- B.2 Lack of effective resolution framework — Likelihood: Low. Impact: High. Considerations: Low probability given current system robustness, but current liquidation-based approach limits least-cost, prompt resolution and cross-border burden-sharing clarity. ¶B.2

*International Monetary Fund — Financial System Stability Assessment Update for Finland, prepared by the Monetary and Capital Markets and European Departments; approved August 5, 2010.*

### 2.      A range of deposit-taking institutions (commercial, cooperative, and savings

### _cr10275 - 2.      A range of deposit-taking institutions (commercial, cooperative, and savings

### Financial system structure and concentration
- Total banking assets were around EUR 350 billion at end-2009 (equivalent to about 200 percent of GDP), up from 110 percent of GDP in 2003.
- Assets of majority foreign-owned banks amount to around 70 percent of all banking system assets.
- Number of credit institutions: 349, but the system is concentrated:
  - Four banking groups account for over 90 percent of total assets.
  - The largest two account for three quarters of lending.
  - Cooperative banks: 263 (most part of OP Pohjola group).
  - Savings banks: 35.
- Financial conglomerates are prominent with strong Nordic cross-border linkages; most groups operating in Finland comprise banks, insurance, securities, and other financial services companies.
- Sampo Group increased its holdings in Nordea to over 20 percent, making Nordea Group (Sweden) Sampo’s associated company; Nordea owns the largest bank in Finland.

### Market dislocations and deposit/lending behavior during the turmoil
- Domestic corporate debt issuance fell sharply in 2008 and was largely replaced by bank credit; this reversed in 2009 as markets normalized.
- Bank deposits grew as agents fled riskier asset classes.
- Ratio of term to demand deposits fell to around 0.3 (2006 level) from a peak of almost 0.6 in 2008: Q3; recently term deposits with maturities greater than one year increased in popularity.
- Despite financial market uncertainty, bank lending continued to grow in response to historically low interest rates.
- Corporate deposit interest rate by maturity and ECB maturing rate dynamics were noted (Source: FIN-FSA).

### Capital markets and institutional investors
- Corporate debt market: outstanding debt equivalent to about 26 percent of bank lending in 2009.
- New corporate bond issues: EUR 1,075 million in 2009, up from EUR 287 million in 2008 (issued in Finland).
- Market capitalization: recovered to EUR 141 billion at end-2009 (equivalent to 82 percent of GDP) from EUR 116 billion at end-2008.
- Insurance companies and pension funds:
  - Suffered negative investment income in 2008; most losses reversed in 2009.
  - Total assets fell in 2008; asset values, solvency, and profitability recovered in 2009.
  - Ongoing simulations in preparation for implementation of Solvency II; final parameters to calculate solvency not yet determined.

### Macroeconomic developments and outlook (implications for financial sector)
- Real GDP fell by 7.8 percent in 2009 as exports collapsed.
- General government overall deficit in 2009: -2.4 percent of GDP (first deficit since 1997), reflecting weak economy and a discretionary stimulus of 1.7 percent of GDP adopted in early 2009.
- Gross debt ratio: 44 percent of GDP at end-2009.
- Automatic stabilizers imply a large budget relaxation, estimated at 3-4 percent of GDP.
- 2010 projections and near-term expectations:
  - Economic activity projected to rebound somewhat in 2010, but unemployment expected to approach 9 percent in 2010.
  - Private consumption expected to remain weak; investment expected to lag.
  - Inflation likely to decline given the sizable output gap.
  - Interest rates likely to remain low for some time to support recovery and maintain financial stability; in the medium term interest rates expected to normalize as the output gap narrows and monetary policy tightens.

### Household and corporate balance sheets (vulnerabilities)
- Household sector:
  - Financial assets largely recovered to pre-crisis levels due to equity market rebound in 2009.
  - Household indebtedness continued to increase to 110 percent of disposable income in 2008.
  - Proportion of loans with floating interest rates (in particular mortgage loans) is over 95 percent.
  - Rising unemployment increases latent credit risk; mitigants include limited mortgage insurance for unemployment/illness and interest rate caps on floating rate mortgages.
- Corporate sector:
  - Firms entered the crisis with solid balance sheets but faced higher borrowing costs and shorter maturities.
  - Ratio of debt to total assets increased from less than 23 percent in 2007: Q3 to over 40 percent in 2009: Q1.
  - Corporates returned to domestic capital markets in 2009; larger corporates returned to international loan and syndicated markets.
  - Rising payment defaults and bankruptcies expected to rise further; SMEs most affected by tighter collateral requirements.
  - Finnvera (public funding for SMEs): loans to SMEs increased from EUR 852 million in 2007 to EUR 1,031 million in 2009.

### Banking sector soundness and resilience
- Competition and efficiency:
  - Despite concentration, the banking sector is highly competitive and efficient by international standards.
  - Net interest margins narrowed significantly and are lower than in most neighboring countries.
  - Cost-efficiency ratios good for large groups but deteriorated with lower margins.
- Asset quality and loan performance:
  - Exposure to toxic assets was minimal.
  - NPL rate increased to 0.7 percent in 2009 from 0.5 percent in 2008.
  - Corporate loans are the main source of credit risk; further increases in NPLs expected for SMEs in 2010.
- Capital adequacy:
  - Tier 1 capital ratio declined slightly in 2008 then improved in 2009 due to rights issues, partial shift toward less risky assets, and expiration of transitional additional capital requirements related to Basel II.
  - Smaller cooperative and savings banks have even larger capital buffers.
- Earnings and margins:
  - Low interest rates depressed earnings markedly: net interest income decreased as interest received on variable-rate assets fell and could not be fully offset by lower interest on deposits.
  - Rising loan losses on corporate credit further reduced profits.
  - Larger banks offset decline in net interest income by increasing non-interest income.
- Liquidity and funding:
  - Deposit behavior and funding profile adjustments noted, including increased deposit rates on some maturities and reliance on wholesale/market-based funding.

### Key statistics and indicators (selected, preserved exactly)
- Total banking assets at end-2009: EUR 349,109 million (Table 3).
- Banking groups assets as percent of GDP: 204.2 (2009) (Table 3).
- Banking groups: Number — 15 in 2009; Domestic-majority owned — 11; Foreign-majority owned — 4; Branches of foreign banks — 15 (Table 3).
- Stock market capitalization: EUR 140,931 million (2009) — equivalent to 82.4 percent of GDP (Table 3).
- Corporate debt outstanding: EUR 18,637 million (2009); issued in Finland: EUR 1,075 million (2009) (Table 3).
- Real GDP growth: -7.8 (2009) and projected 1.2 (2010) (Table 4).
- Unemployment rate: 8.3 (2009) and 8.8 (2010 projected) (Table 4).
- Consumer price inflation (harmonized): 1.6 (2009) and 1.4 (2010 projected) (Table 4).
- General government balance: -2.4 percent of GDP (2009) and projected -4.1 percent of GDP (2010) (Table 4).
- Gross debt (EMU definition): 43.8 percent of GDP (2008) and 49.7 percent of GDP (2010 projected) (Table 4).
- Household indebtedness: 110 percent of disposable income in 2008 (text).
- Finnvera loans to SMEs: EUR 852 million (2007) and EUR 1,031 million (2009) (text).
- NPL rate: 0.7 percent in 2009 (text and Table 5).
- Net interest margin examples: declined; charts and BankScope-derived calculations referenced (figures in text charts).

*Source: FIN-FSA; Bank of Finland; Ministry of Finance; IMF staff projections as presented in the source document.*

### 16.      Overall, Finnish banks are quite dependent on wholesale funding—although less

### _cr10275 - 16.      Overall, Finnish banks are quite dependent on wholesale funding—although less

### Funding, liquidity, and market access
- Finnish banks are quite dependent on wholesale funding—although less so than other Nordic banks—but access to markets has not been a concern.
- Liquidity ratios (e.g., cash and trading assets to total assets) are lower than in neighboring countries.
- The main banking groups have good credit ratings and can easily access funding from the market, the parent banks, and/or the ECB.
- Ratings cited: Nordea Bank Finland Group and OP Pohjola Group are Aa2 while Sampo Bank Group and Aktia are A1.
- There is the potential for bank funding costs to be pushed wider by stricter liquidity rules, higher yields on bank bonds, and increasing sovereign spreads—the latter creates a potential channel of contagion from the sovereign to the banking sector.
- Liquidity buffers are low for some banks, but a broader definition of liquid assets (including securities eligible for ECB refinancing) suggests lower risk because of banks’ large holdings of such securities.
- Foreign-owned banks’ liquidity is managed by the group treasury, which can distribute liquidity within the group.

### Stress testing results — key findings
- Stress tests confirm that credit risk is the key source of risk.
- Capital adequacy of the system would remain above the mandatory level under most stress scenarios given large capital buffers. Only an extreme increase in the rate of default—similar to that observed during the 1990s banking crisis—or a massive default of mortgage loans would bring capital adequacy below the regulatory norm.
- Finnish banks are vulnerable to concentration risk given banks’ exposure to their largest clients; some of the largest banks act as liquidity hubs and would become immediate channels of contagion in a major crisis.
- Market risk for the system as a whole seems relatively modest; single-factor shocks for equity price and exchange rate risk have a relatively small impact on banks’ capital adequacy because banks trade mostly on customers’ behalf and hedge positions.
- Residential real estate shocks have minor effects given historically low mortgage default rates and limited direct lending to commercial property.
- Interest rate risk appears modest in direct effect because of minimal maturity mismatch, but predominance of variable-rate lending implies borrowers’ debt service could increase sharply when market rates return to historical averages.
- Risk-mitigating practices mentioned: loan insurance, interest rate caps on mortgage loans, mortgages with a fixed monthly payment amount.
- Banks indicated that clients’ debt-service capacity is stress tested to interest rate levels of 6 percent, and that current debt service-to-income ratios are quite low.
- FIN-FSA should monitor bank mortgage lending practices (including pricing and LTV ratios) and household debt service capacity regularly, and ensure banks follow the recently issued guidance on LTV (with a maximum of 90 percent).

### Liquidity stress testing and contagion
- Liquidity stress tests simulated deposit outflows of households and corporates and a contraction in the interbank market; two definitions of liquid assets were used (narrow and broad), and haircuts were applied.
- Results: liquidity buffers are low—especially for one bank—under the narrow definition; broader definition reduces perceived risk.
- Contagion analysis using contagion maps and cascading-default simulations shows high contagion risk owing to the high degree of concentration; some large banks serve as system liquidity hubs, and a smaller hub exists among cooperative and savings banks.

### System resilience and scenarios
- Stress tests suggest the banking system is resilient to combined shocks; multi-factor scenarios including sharp increases in NPLs and declines in interest rates and asset prices would decrease capital for some small banks, but the four largest banking groups would maintain sufficient capital adequacy.
- A “loss of confidence” scenario replicating the 2008–09 crisis leaves capital adequacy well above the regulatory norm.
- FIN-FSA conducted additional stress tests after the mission’s departure in the context of an EU-level exercise; the results were broadly in line with the findings reported here.

### Selected stress test table excerpts (Based on end-December 2009 data)
- Pre-shock CAR (end-December 2009) 12.314.525.8
- Credit Risk
  - 1 Increase in NPLs by 700 percent 9.411.825.00
  - 2 Increase in NPLs to 13 percent (1990s banking crisis levels)2.47.024.631.6
  - 3 30 percent of loans to commercial real estate turning into NPLs11.213.025.60
  - 5 30 percent of mortgage loans turning into NPLs5.810.625.824.5
- Interest Rate Risk - Effect on Net Interest Income
  - 1 Parallel upward shift of the interest rate by 200 basis points13.515.329.90
  - 2 Parallel downward shift of the interest rate by 100 basis points11.514.123.80
- Exposure Concentration
  - 1 Default of banks' largest 10 exposures0.0...6.9100
- Asset Price Risk
  - 1 Equity prices decline by 70 percent11.414.225.80
  - 2 Residential real estate prices decline by 30 percent11.614.025.80
- Multi-factor shock
  - 1 Increase in NPLs by 700 percent, and decline in interest rates by 100 percent, equity prices by 70 percent and commercial and residential estate prices by 30 percent 4.610.424.91.1
- Scenario Analysis (Cumulative to 2011)
  - 1 Double dip14.113.514.4
  - 2 Global financial shock13.412.412.5
  - 3 Loss of confidence13.112.011.7

### Insurance and pension funds
- Insurance companies and pension funds are more sensitive to market risk but maintain acceptable solvency levels except for some life insurance companies, which would become insolvent under the most extreme equity price scenario due to a large equity portfolio (around 20 percent of assets).
- Interest rate shocks up to 400 basis points (either direction), equity price decreases up to 70 percent, real estate and exchange rate shocks (up to 30 percent) were considered.

### Supervisory and regulatory challenges — recommendations
- Reform of prudential regulation
  - The new Basel Committee measures (including proposed capital deductions and liquidity requirements such as the Net Stable Funding Ratio (NFSR)) could significantly affect some institutions, particularly cooperative structures with mutual shareholdings and banks relying on short-term wholesale funding.
  - These measures are likely to be introduced gradually.
- Cross-border supervision
  - The significant presence of foreign banks requires effective home-host supervisory cooperation; concerns exist around branch conversion plans by Nordea and Danske Bank.
  - Authorities should pursue improvements pending EU decisions, building on Nordic cooperation, including: (a) more explicit information exchange; (b) clear understanding on burden sharing; (c) increased harmonization of how international standards are applied; and (d) a common supervisory approach and a common reporting system.
- Dealing with systemic risk
  - Broaden systemic monitoring to include the insurance sector and all major cross-border connections; integrate BOF’s payment system simulator into regular systemic risk analysis.
  - Develop a systemic stability framework and consider regional measures (for example, adopting on a regional basis the Swedish “stability fee” levied on bank liabilities) to address moral hazard posed by institutions that may be considered too important to fail.
- Improvements in supervisory practices
  - FIN-FSA should reinforce powers for early intervention; consider improving the usability of formal powers in the Act on the FSA (for example administrative fines and penalty payments), including extending coverage beyond securities markets and increasing maximum amounts.
  - Enhance cross-fertilization between banking and insurance supervision within FIN-FSA, and reach international agreements with relevant home supervisors on deepening cross-sectoral supervisory cooperation.
  - Improve stress testing methodology: enhance the macro-financial model linking macro variables to NPLs on a bank-by-bank basis; develop models projecting profit and loss items bank-by-bank across the cycle; construct longer time series of individual bank data using observations available since 1996; ensure offsite supervision and financial stability departments have ready access to bank and sectoral level data while preserving confidentiality.
  - Increase transparency by publishing stress testing results in the English version of the Financial Stability Report or other publication and consider quarterly dissemination of a table of core financial soundness indicators.

*Source: FIN-FSA, Bank of Finland, and IMF staff estimates as presented in the provided content.*

### 34.      A detailed review of selected banking supervision core principles highlights a

### _cr10275 - 34.      A detailed review of selected banking supervision core principles highlights a

### Enhancements to banking supervision
- FIN-FSA should ensure that liquidity risks receive greater coverage in its risk assessments.
- FIN-FSA should improve the granularity of its standards on liquidity risk management (in progress), and analyze in greater detail banks’ funding profiles with a view to discussing possible structural changes, to prepare for the upcoming changes in regulation of liquidity risk.
- Authorities should pursue clear agreements on specific information to be distributed on a regular basis by home supervisors (above and beyond what is provided by supervisory colleges and through other cross-border arrangements), to overcome obstacles to obtaining a sufficient insight in the solidity of foreign groups that are active in Finland.

### Insurance supervision
- Insurance supervision is in line with international standards and earlier FSAP recommendations have been implemented.
- FIN-FSA is reviewing supervisory processes (e.g., risk assessment and onsite inspection programs) to combine best practices of previously separate supervisory authorities and create a consistent and comprehensive supervisory framework for banking and insurance supervision.
- The legal framework for insurance supervision was revised in 2008 and FIN-FSA closely follows relevant principles regarding insurance supervision.
- Recommendations from the 2001 FSAP implemented:
  - add independent experts to the board;
  - obtain a legal basis for the early intervention mechanism;
  - enhance investment and derivatives expertise.

### Securities market supervision and reporting
- The securities market legal framework has undergone many changes since the 2001 FSAP, triggered largely by changes in the EU legal framework, including the Markets in Financial and Instruments Directive (MiFID).
- Authorities are working to further update the Securities Markets Act.
- FIN-FSA investigates suspicions of market abuse; information collection is more challenging due to increased internationalization and fragmentation of trading.
- FIN-FSA is implementing a transaction reporting system to provide more comprehensive information on trading of listed securities and derivatives.
- Further improvements that would enhance effectiveness:
  - capabilities to monitor over-the-counter trading of derivates;
  - linking individual trades to individual investors via standardized ID’s.

### Market infrastructure developments
- Major changes in market infrastructure include replacement of separate payment systems laws by the Payment Services Act and Payment Institution Act that entered into force on May 1, 2010.
- As a member of the European System of Central Banks (ESCB), the BOF is responsible for oversight of payment systems in Finland and should “participate in maintaining the reliability and efficiency of the payment system and overall financial system and participate in their development.”
- Three major payment systems operating in Finland:
  - BOF TARGET2 component system (TARGET2-Suomen Pankki system);
  - the POPS inter-bank system for express transfers and checks (POPS);
  - the PMJ system for retail payments (PMJ).
- In December 2008 a license for payment transmission was granted to ACH Finland Plc (ACHF).
- Replacement of the POPS and PMJ systems in the next few years with the Euro Banking Association STEP2 system (subject to Eurosystem oversight) for processing national payments is under consideration.
- Securities settlement:
  - Euroclear Finland (EFi) is working on migration to Euroclear’s Single Platform in 2012–13.
  - Securities settlement is performed by the EFi, comprising APK settlement systems for equity rated securities (OM) and for non equity rated securities (RM), operating on a continuous and real-time basis.
- In mid-November 2009, mandatory CCP-clearing was introduced for large and mid-cap cash equities traded on Nasdaq OMX Helsinki.
- CCP-services for the Finnish market are provided by the European Multilateral Clearing Facility (EMCF).
- BOF and FIN-FSA have signed a multilateral MOU with Dutch, Danish, Icelandic and Swedish counterparties on cooperation in supervision and oversight of the EMCF.

### Safety net and crisis management — overview
- Key areas requiring further enhancement following the global financial crisis:
  - identification and monitoring of systemic risk;
  - the bank resolution framework, for both domestic and cross-border institutions;
  - the operation of the deposit insurance fund.
- Frameworks for crisis preparedness and management and for emergency liquidity assistance (ELA) are in place.
- Cross-border dimensions are particularly challenging despite current high degree of cross-border cooperation with home supervisors.

### Bank resolution framework — cross-border and domestic
- Cross-border resolution:
  - Effective cross-border resolution framework is necessary to complement strong cross-border supervision.
  - Recent MOUs with Nordic and Baltic countries strengthen regional crisis readiness and may address weaknesses identified in the Nordic Financial Crisis Exercise carried out in 2007.
  - Authorities must address: seeking international coordination at an early stage; communicating effectively with the public; avoiding ring-fencing and immediate domestic resolution actions; ensuring domestic coordination; analyzing legal and burden-sharing implications of joint recapitalization decisions.
  - Effectiveness of agreements needs periodic testing and review, especially provisions on burden sharing.
- Domestic resolution:
  - Significant room for improvement exists in the domestic bank resolution regime.
  - Absence of a specific insolvency framework for banks means deposit institutions are subject to the same liquidation proceedings as any other company, reducing effectiveness of resolution, likely increasing cost, and potentially delaying depositor payouts (as observed in a recent small institution failure).
  - Current intervention mechanisms and limitations:
    - Act on the Temporary Interruption of the Operations of a Deposit Bank (1509/2001): designed to manage a sudden bank run by temporarily freezing a bank’s operation, with risk of undermining confidence and causing systemic consequences.
    - Act on the Government Guarantee Fund (379/1992): entails state participation in a bank’s capital and is subject to EU approval.
    - Act on Credit Institutions: does not provide precise power and intervention criteria but allows supervisory authority some freedom to shape actions.
    - Example: Kaupthing branch intervention relied on flexible interpretation of banking law due to lack of precise powers.
  - Authorities should consider a special resolution regime for banks and financial groups to support orderly and least-cost resolution. Key features to consider:
    - authority for mandatory debt restructuring;
    - purchase (of assets) and assumption (of liabilities) transactions;
    - use of bridge banks to maintain going-concern value;
    - temporary public ownership;
    - merger with other banks;
    - liquidation.
  - A special resolution regime may include “official administration” of a troubled institution; fiscal authorities should be involved when budgetary implications exist, acting on a proposal from FIN-FSA.
  - The regime should provide a mechanism to override shareholder rights when public interest requires it, enabling timely mandatory restructuring measures and burden sharing across debt holders rather than blanket bail-outs.
  - Compulsory liquidation to minimize crisis cost and contagion effects would remain an option.
  - To facilitate dissolution of group structures, regime features might include:
    - multiple insolvency proceedings rather than a single group proceeding, respecting separate legal personalities;
    - no legal requirement for parent company to satisfy subsidiaries’ obligations (or vice versa).
  - Constitutional constraints to set up a bank insolvency regime may need to be overcome.

### Deposit Insurance Fund (DGF)
- Ongoing EU-level reform of deposit insurance regimes will require important operational changes in Finland’s DGF.
- Key characteristics of Finland’s DGF:
  - mandated by law and managed by contributing banks;
  - pre-funded and collects risk-based premiums;
  - assets under management amounting to EUR 629 million at end-2009, corresponding to 1.1 percent of the system’s deposits by households and nonfinancial corporation.
- Coverage changes:
  - In 2008, coverage increased from EUR 25,000 to EUR 50,000;
  - by end-2010 it will be further increased to EUR 100,000, in line with the amended DGS Directive 94/19/EC.
- Payout period changes intended:
  - current payout period: 3 months, extendable up to 3 times to 1 year;
  - authorities intend to shorten substantially to 20 working days, extendable 10 more days;
  - this falls short of current EU proposals to ensure payouts within 1 week.
- Operational implications:
  - Authorities will need to ensure DGF operational resources enable the new mandate.
  - The recent failure of a small domestic bank provides an opportunity to test scheme performance.
- Recommendation:
  - Authorities should consider an evaluation of the DGF against the Core Principles for Effective Deposit Insurance Systems (issued by the Basel Committee on Banking Supervision and the International Association of Deposit Insurers in 2009) once an assessment methodology is available.

### Emergency Liquidity Assistance (ELA)
- Existing ELA framework appears solid but may need additional clarity on cross-border access to ELA.
- First line of defense is the ECB refinancing framework, which has shown flexibility to meet even a systemic liquidity crisis.
- BOF contingency arrangements:
  - BOF has developed a contingency plan to provide short-term collateralized financing in case a solvent systemically important supervised entity faces a liquidity crisis.
  - Process foresees collaboration with FIN-FSA, including determining eligibility and adequacy of collateral.
  - Arrangements with other central banks exist through crisis management MOUs but do not cover certain operational cross-border dimensions, e.g., explicit listing of possible collateral from another jurisdiction eligible for ELA.

*Source: _cr10275 - 34.      A detailed review of selected banking supervision core principles highlights a*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10275.pdf_