Director General’s review
The Finnish financial sector has remained stable. Even so, it is not immune to low interest rates hampering profitability, the weakening of the economic operating environment and changes in the competitive environment challenging old business models.
The FIN-FSA has reformed its strategy for 2020–2022. The new strategy highlights the need to redirect supervision based on changes in the operating environment. The FIN-FSA's scope of supervision has become increasingly diverse. This requires intense prioritisation of supervision and its allocation to the highest-risk entities and functions. Digitalisation, climate change and anti-money laundering were incorporated into the strategy as special subsectors.
Let me take an example of changes in the economic operating environment. In its most recent risk dashboard, the European Systemic Risk Board (ESRB) warned about the mispricing of risks. The protracted rise of asset prices, investments in illiquid instruments and problems in fund redemptions that have already materialised to date have increased the European supervisors' concern about the adequacy of funds’ liquidity in a stress situation. Based on our thematic review of real estate funds last autumn, we noted ourselves that Finnish real estate funds should improve their valuation practices and liquidity management. Funds have no experience of a liquidity freeze in weak market conditions. The supervision of funds’ liquidity is therefore one of our areas of focus in 2020. The uncertain market conditions further increase the importance of the issue.
Digitalisation, climate change and anti-money laundering highlighted in our activities
Digitalisation has changed and will further change the operating logic of the financial sector. From the supervisor's perspective, this means that the supervisor must not only understand the benefits of digitalisation for business but also the risks of digitalisation, whether they be related to the use of data and artificial intelligence or cyber risks. In the latter case, cooperation between authorities is a must. On the other hand, the supervisor also has another role – to look after the availability of financial services. At the same time, as digital services become increasingly diverse and user-friendly, it must be borne in mind that one in five Finns has poor digital skills. The availability of services for them must also be ensured.
The impacts of climate change on the financial sector are manifold. From the perspective of financial stability, it is important to consider the impacts of climate change and climate policy on the risks faced by supervised entities when assessing these risks. In our supervisory work, we have also participated in defining which investments may be considered green. It is important to try to prevent so-called greenwash of investments while ensuring that retail investors have access to adequate and understandable information on the greenness of investments. It is also important not to promote green investments by easing the supervised entities’ capital requirements, since capital requirements must remain risk based also in the future. All in all, climate change has significant impacts on supervised entities' risk management and risk-taking.
The third subarea in the strategy is anti-money laundering. European and, in particular, Nordic banks have been subject to heavy criticism in recent years after failing their monitoring obligation and allowing massive doubtful money transfers. The FIN-FSA was also reprimanded by the Financial Action Task Force (FATF), which focuses on anti-money laundering and countering terrorist financing, for inadequate supervision of anti-money laundering. We have learned our lesson and reinforced both supervisory resources and the intensity of supervision. The guiding principle is risk-based supervision, which means that supervision should focus on sectors with the highest risk of being abused in money laundering. The principle of risk-based supervision should also apply to entities supervised by the FIN-FSA. They should not focus their monitoring only and mainly on easy targets, such as normal consumer-customers.
Supervision of anti-money laundering cannot, however, be dealt with by national supervisory actions alone. Since crime is supranational, so must be its supervision. The FIN-FSA was one of the first to suggest the establishment of an EU-wide anti-money laundering authority based on a framework similar to the ECB banking supervision. This entails the establishment of a single supervisor, which will draw on the labour input of the national supervisory authorities. Many member states which previously opposed to the initiative are gradually converting to support it.
Measures to contain household indebtedness continue
In the autumn, a working group established by the Ministry of Finance finalised its proposal on tools to prevent excessive household indebtedness. In public discussion, the main attention has been on the debt-to-income ratio and its level, and the question has surfaced as to whether a ceiling linked to income would limit the availability of credit to recent graduates or people in short-term employment relationships. In these discussions, it has often been overlooked that the proposal includes leeway for such situations, i.e. the bank is able to determine within the boundaries of this flexibility the loans to which the limit need not be applied.
Another important subarea is the transfer of the supervision of payday loan companies to the FIN-FSA. Instant loans are a societal problem and therefore a firm grip and proper tools are needed to supervise them. Regulation must define in more exact terms how the customer's repayment capacity should be assessed and how high-risk customers should not be granted credit at all. Once this limit has been defined, it is possible for the supervisor to intervene.
Amendments to capital adequacy requirements
The implementation of the so-called Basel III finalisation package will introduce a considerable tightening of capital requirements for banks. The European Commission will give its proposal on the issue later this year. The purpose of the package is to restrict the reductions provided in the banks' capital needs by their so-called IRB models. Nordic banks are using these internal models more than the average. In addition, they have a high share of low-risk housing loans whose risk weights are low due to their low credit loss history. In fact, the regulatory change has the strictest impact on these. In implementing the reform, attention should be paid to impact assessments in order for the outcome to be as balanced as possible. In my opinion, a balance can be achieved while ensuring that the Basel principles are respected. The risk-sensitivity of capital adequacy calculations should not be reduced too much, and the significance of risk management must be emphasised further.
Another factor widening the gap between the capital requirements for banks in various member states are the macroprudential buffers. Their use within the EU has not been harmonised and there are indeed considerable differences in their application. For banks, this means that a level playing field does not prevail. Surely, the level of the buffer should also reflect, among other things, the structure and size of each country's banking sector; Finland, for example, has high structural capital buffers for this very reason.
In the insurance sector, assessment of the impacts of the reform of Solvency II regulation on supervised entities is ongoing. In particular, the new discount rate assumption applied in the solvency calculations is in need of a reform, since the current level of the discount rate is too high relative to market rates. This means that the amount of the companies’ technical provisions has been underestimated with respect to long-term liabilities in particular. Similarly, the treatment of interest rate risk in solvency calculations should be revised to take the current interest rate environment into account. If the objective is not to increase the level of regulatory requirements, there should be a careful assessment of which Solvency II calculation parameters should be revised and how to achieve a balance. From our perspective, it is important that regulation is as risk-based as possible and promotes the principle of proportionality.
Boundaries of permitted activities have been clarified
Last autumn, the FIN-FSA issued a supervision release on the scope of disability risk management allowed for pension insurance companies. This is an important issue, since we had noted some companies slipping beyond their allowed field of business, i.e. social insurance, in providing occupational wellbeing services. The management of disability risk as a business is allowed for pension insurance companies, but only when it is pursued as part of the insurance business, namely risk management aimed at reducing disability risk at the company's own risk. The funds must not be used for other purposes, regardless of how good the intentions might be. The supervision release and related memorandum provide answers to questions posed by the sector on the scope of allowed activities. Since the issue at hand is not a need for new regulation but compliance with existing regulation, I do not see a need for clarifying legislation in this regard. Legislative amendments would require a careful overall and impact assessment both from the perspective of the structure of the earnings-related pension scheme and its impacts linked to the EU Accession Treaty. The FIN-FSA will continue its follow-up work in the matter also in the current year in order to ensure that all companies are operating within the boundaries of regulation.
European financial sector in transition
One of the objectives of the EU's Capital Markets Union project has been, in particular, to reduce the dependency of small and medium-sized enterprises on bank finance. The capital markets union has progressed slowly, however, and the share of bank finance has actually grown recently. In order to achieve the objective, cross-border investment within the EU should be facilitated, excessively detailed regulation should be reduced, and measures should be taken, where feasible, to harmonise bankruptcy and corporate law, in particular. Actions should be taken in the short term to facilitate IPOs and the availability of high-quality financial analysis on SMEs, while keeping investor protection in mind.
At the end of January this year, the United Kingdom exited the EU after a long and burdensome process. The immediate impacts of Brexit on the Finnish financial sector are minor. The City of London will also remain a major financial centre in the future. It is therefore important that the European Commission is able to grant the UK so-called equivalence status, which would enable smooth operation between the EU and UK also in the future. Of course, this status should only be granted in the event that the UK continues to meet the equivalence requirements.
From the FIN-FSA’s perspective, the decision of the UK to exit the EU is a loss. Our UK colleagues, similarly to the FIN-FSA, have represented a stance favourable for integration and supported a principles-based approach. Our UK colleagues possess outstanding professional skills, practical problem-solving abilities and a way of seasoning their comments with wry British humour. Without them, we feel like a part of ourselves is missing.
In pursuing its supervisory duties, the FIN-FSA is subject to ever closer external scrutiny. We are being assessed by the various European Supervisory Authorities: EBA, EIOPA and ESMA, the European Commission, the FATF and naturally our cooperation partner, the ECB. We utilise these assessments in developing our operations and analytical capabilities. The assessments also help us prioritise our activities and improve our efficiency. Our target for these assessments is to be, if not a grade A student, then at least an A- student.
During the past two years, a hundred new experts have been hired by the FIN-FSA, some of them into new positions and some to replace departing personnel. Our objective is to have this new expertise working at full speed as soon as possible. A further goal – in accordance with our strategy – is to ensure the competence and wellbeing of our personnel, and that we are viewed as a valued employer both from our employees' perspective and externally.
I would like to thank all of our employees for their good work.
In Helsinki on 2 March 2020
Photo: Antti Aimo-Koivisto, STT-Lehtikuva