​The situation in the European financial markets has improved, but economic growth prospects are weak. The risks to the stability of the Finnish financial system mainly stem from the poor growth outlook and household indebtedness. The risks related to the debt burden are amplified by housing loans being linked to market interest rates that are historically low.

‘Ongoing debt accumulation erodes the ability of households and, simultaneously, of the whole economy to adapt to negative economic surprises,’ said Pentti Hakkarainen, Deputy Governor of the Bank of Finland, at the press briefing for the Bank of Finland journal Euro & talous dealing with financial stability.

It is important to ensure that tools for reining in excessive debt accumulation are in place. On the basis of international experience, loan-to-value regulation provides a way of dampening excessive growth in lending for house purchase and the related unfounded rise in asset prices. ‘There are good reasons to ensure the readiness to make use of macroprudential tools in time, such as loan-to-value regulation and a systemic risk buffer. History has shown that the adverse developments that these tools are designed to address often translate into excesses without the adverse effects being evident,’ explained Deputy Governor Hakkarainen.

In Finland, banks’ capital adequacy ratios have remained sound: there are sufficient own funds and they are mainly of high quality. Even so, the conditions for bank profitability deteriorate as the low level of interest rates reduces net interest income. The largest banks have been able to draw on their diversified business operations and have increased their investment and other income.

A well-capitalised banking system is able to maintain its lending capacity in economic downturns. The financing situation for non-financial corporations is relatively good in Finland compared with other euro area countries, and interest rates on corporate loans are at historically low levels. However, access to finance is deteriorating and margins on small loans, in particular, have widened. ‘The conditions for diversifying the sources of funding for non-financial corporations must be taken care of. It is therefore important to identify possible problems in corporate financing,’ emphasised Mr Hakkarainen.

Upcoming regulatory reforms will require less action and costs from well-capitalised banks that are strong in terms of their liquidity than from weaker banks. Tightening regulation and low interest rates, in conjunction with subdued economic performance, pose a challenge to the financial sector’s current business models. Bank funding has also become more costly, amid fading investor interest towards banks. Even though funding conditions have been recently improved of Finnish banks in Finland.

As a lesson from the financial crisis, the ability of the financial system to bear risks needs to be strengthened further. ‘Finland is a country susceptible to cyclical fluctuations, whose banking sector is large, concentrated and connected with the international economy. This is why international financial regulation is useful for us,’ Hakkarainen noted.