Household and public sector debt in Finland contain worrying features in the present situation where the current account has moved into deficit and net external debt is growing. ‘The risks to the Finnish financial system must be addressed before they have time to grow too large,’ said Pentti Hakkarainen, Deputy Governor of the Bank of Finland, at the release of the latest financial stability issue of the journal Euro & talous.

Most housing loans in Finland are tied to variable interest rates, which are currently at an exceptionally low level. A rise in interest rates and growth in unemployment could trigger risks that would threaten the development of the entire national economy. A growing number of Finns with housing loans have a debt burden that is large relative to their income, and a substantial proportion of new housing loans for first-time buyers have been granted without any self-financing share.

‘Household indebtedness should be reined in by reducing the incentives to taking on debt and increasing awareness of interest rate risks and other risks relating to large debts and the various different loan products,’ said Deputy Governor Hakkarainen. Moreover, banks must strictly observe the Financial Supervisory Authority’s recommendations on assessing the debt servicing ability of housing loan applicants and being cautious towards large loan-to-value ratios.

Finnish authorities must also be provided with stronger means than at present to combat risks threatening the stability of the financial system as a whole. ‘The authorities need to be equipped with discretionary means to moderate excessively rapid growth in total lending and housing loans, at least,’ stressed Deputy Governor Hakkarainen.

The capital adequacy position of Finnish banks is, taken as a whole, strong. The lion’s share of banks’ own funds comprise core Tier 1 capital, which has the highest capacity to cover losses. However, Finnish credit institutions’ combined ratio of equity to non-risk-weighted assets (the equity ratio) has, taken as a whole, clearly declined. The trend has, admittedly, varied from one institution to another.

Part of the decline in equity ratios can be attributed to how banking groups have shifted their international activities to their subsidiaries operating in different countries. Supervisory authorities should closely follow balance-sheet growth and declining equity ratios in credit institutions. Banks operating in Finland differ in terms of their structures and business models, which places special demands on regulation and supervision.

Short-term risks to the stability of the Finnish financial system remain external in origin. The risks to financial stability in the euro area remain substantial. The negative interlinkages between excessive public debt and the stability of the banking system have been further reinforced as a consequence of the euro area debt crisis.

‘Structural measures to repair the weak aspects of the European banking system should not be delayed,’ emphasised Deputy Governor Hakkarainen. ‘Providing support to non-viable banks burdens the public finances, keeps the banking system vulnerable and distorts the competition between healthy and weak banks. The operations of these banks should be reorganised or else wound down in a controlled manner,’ averred Hakkarainen.