Current threats to the stability of the Finnish financial system are primarily external in origin. Market confidence in the debt-servicing capacity of some euro area members is running low. However, confidence in the debt-servicing capacity of the large euro area countries remains intact, which reduces the risk that the crisis could spread.
The weakest European banks have only thin capital adequacy buffers, their sovereign risks are typically large and they find it very expensive or even impossible to acquire market funding in its various forms. In those euro area countries experiencing a sovereign debt crisis, sovereign risk is making it harder for even well-capitalised banks to acquire funds.
Uncertainty over the quality of European banks’ balance sheets and concerns that the problems could spread more widely through the financial system could, in a worst-case scenario, also make it harder for banks currently considered secure, like Finnish banks; to acquire market funding.
Banks in the EU should reinforce their balance sheets to enable them to support the recovery in economic growth. ‘European stress tests should be used as the basis for determined action to strengthen the capital base of weak but viable banks, primarily through private-sector solutions. Non-viable banks should be restructured or their activities wound down in a controlled manner,’ said Deputy Governor Pentti Hakkarainen at the press conference for the latest financial stability issue of the Bank of Finland journal Euro & talous.
The ability of the financial system as a whole to withstand shocks should be systematically reinforced in order to reduce the probability of financial crises and their side-effects. ‘Finnish authorities must be equipped with adequate powers to take measures to prevent the realisation of systemic risks that threaten the stability of the national financial system,’ said Hakkarainen. Such macroprudential measures would seek to eg put a brake on excessive household and corporate indebtedness and excessive rises in asset prices.
The Finnish financial system has been developing in a more stable direction since autumn 2010. The picture regarding household debt does, however, contain some worrying features. The proportion of highly indebted households grew rapidly throughout the first post-millennium decade. Continued growth in household debt will undermine the ability of both households and the economy to adapt to economic disturbances. ‘Households need to determine the size of their loans according to their ability to service these loans and prepare for the possibility of interest rates that are higher than the present rates. Banks must not grant loans that are excessive in terms of the collateral and debt-servicing capacity of the borrowing household,’ stressed Hakkarainen.
One problem faced by Finnish companies is the narrowness of choice regarding alternative sources of funding. ‘The domestic capital market is fading. Broadly based cooperation to develop the market is essential,’ said Hakkarainen.
Domestic payment and settlement systems are already largely integrated with the pan-European infrastructure. Integration is understood as a way to achieve greater efficiency in payment transfers. Introduction of European SEPA credit transfers has made rapid progress. The changes have, however, caused a regrettably large number of payment delays. ‘Service providers must ensure that their systems serve their Finnish customers more reliably in future,’ stressed Hakkarainen.
Euro & talous 2/2011, the latest special issue on financial stability, contains an extensive overview of the banking and insurance sector’s operating environment and infrastructure.