Deputy Governor Pentti Hakkarainen, Bank of FinlandSummary of the presentation at Banka Slovenije19 July 2010
My intention today is to present an overview of our experience of unifying the financial supervision. The new Financial Supervisory Authority is at the same time an independent institution and an integral part of the Bank of Finland. This may sound like a contradiction in terms, but I will explain later why it is not.
It is less than two years since the escalation of the financial crisis in September 2008. We all remember the collapse of Lehman Brothers and the subsequent rescue of the American International Group (AIG) by the US authorities. In the euro area, heads of state and government as well as central bank governors held emergency meetings to prevent a collapse of the banking system. Not only banks but even some countries like Iceland faced unprecedented problems, with repercussions all over Europe.
In Finland, our financial supervision authority had to take special actions on the branches of the Icelandic banks operating in our country. The financial system as a whole, however, remained stable. Due to the potential adverse effects of global financial market disturbances, people were nevertheless nervous. This was reflected in a temporary increase in the currency in circulation. Preparations for managing a worsening situation pushed us to work hard. At the Bank of Finland and at the Financial Supervision Authority this was a truly hectic time. Our cooperation with the Ministry of Finance was also intense, when new legislation was put forward to parliament in order to guarantee the stability of the financial system.
Internationally, we are still in a mode of crisis management, and it is too early to evaluate the success of our ongoing work. There are, however, serious questions to be asked about how we got into the financial mess. From a central banking and supervision perspective, we should look at the work that we did, and we should not hesitate to try to identify what we possibly have done wrong, and what we should do better in the future.
One and perhaps the most important lesson of the lessons from the financial crisis is the need to ensure that important activities and trends do not escape the eyes of supervisors. Another lesson is that supervision should not suffer from inadequate coordination between central banks and financial supervisors. This second lesson implies that there was not enough dialogue between micro and macro supervision, and that micro-supervisors’ knowledge of the risk exposures of individual institutions was not available to macro-supervisors. The third lesson is that the authorities responsible for the financial stability must have appropriate powers to act promptly if needed.
Let me now turn to the unfolding of the financial and economic crises, and some conclusions that we at the Bank of Finland feel should be made. The different phases of a financial and economic crisis typically follow the pattern which starts from growing indebtedness, leads to the bursting of the asset price bubble, is followed by a banking crisis and as a result, bank lending dries up. The final phase is a sovereign debt crisis, with potential feedback to the banking sector and renewal of the banking crisis.
The point here is that successfully preventing this chain of events from occurring requires intensive cooperation between various authorities. One of the main functions of the central banks is to provide sufficient liquidity to the financial system. Although this is of course of utmost importance, it is not, by itself, sufficient to extinguish all flames of the big "financial fire".
As we all know, the tightly interlinked financial systems of today require international cooperation to safeguard financial stability. The financial crisis has intensified the development of common euro area and EU supervisory frameworks.
The Bank of Finland monitors the financial system as a whole and its objective is to maintain stable, reliable and effective financial and payment systems in Finland. The Financial Supervisory Authority (FIN-FSA), operating in connection with the Bank of Finland, supervises individual banks, insurance companies and securities markets, i.e. covering all the relevant institutions operating in the financial markets.
FIN-FSA was founded in 2009, but its predecessor, called the Financial Supervision Authority, was connected to the Bank of Finland already in 1993. In 2009 the Insurance Supervisory Authority became part of new organization – the Finnish Financial Supervisory Authority. The decision to merge financial and insurance supervision was taken prior to the financial crisis but experiences of financial crisis confirmed the need for comprehensive supervision of financial sector risks and close cooperation with the central bank.
FIN-FSA is an autonomous authority which is independent of political decisions but operates administratively in connection with the Bank of Finland. FIN-FSA has its own board of non-executive directors. The board consists of five members (Bank of Finland, Ministry of Finance, Ministry of Social Affairs and Health + two independent members) and the Deputy Governor of the Bank holds the chairmanship of the board of the FSA. The annual FSA-budget is approved by FSA board and confirmed by the Bank of Finland.
Clearly great benefits derive from the institutional arrangement in Finland. The combination of macro and micro prudential oversight and supervision is just "what the doctor ordered" after the financial crisis. We had this in place already in 2009 in a comprehensive manner. There is no duplication of work – and this is an important aspect for endeavoring to work as efficiently as possible. The Bank of Finland and the FSA also share common data, exchange information and cooperate in both analysis and stress testing. The administrative services are shared, or more precisely provided to the FIN-FSA by the Bank of Finland.
Based on our experience – although preliminary – the new FIN-FSA works well as an independent authority and close to the central bank by covering all relevant financial institutions. It also seems to fit nicely to the proposed and forthcoming European supervisory and regulatory framework.