The operating environment of the financial sector deteriorated in 2023, as the high inflation and interest rate level as well as weakening economic growth took a toll on households and companies.¹

Feeble cyclical development in combination with rising management, repair, construction and financing costs took a particularly heavy toll on the real estate and construction sector. At the same time, the revenues of the real estate and construction were under pressure as sales of constructed residential properties cooled off and competition for tenants dampened the potential for raising rents. The slow-down in construction was particularly steep, and real estate prices declined in 2023. Declining real estate prices, sluggish sale volumes and market uncertainty, in turn, increased credit, investment and liquidity risks in the financial sector.

The Finnish financial sector is considerably exposed to the residential property and real estate markets. The exposures are in many respects larger than in Europe on average. The proportion of non-performing housing company loans rose last year, and growth in housing company loans with elevated credit risk continued to increase. The proportions of credit with elevated credit risk in the real estate and construction sector also continued to rise.

Real estate risks also reflected on employee pension institutions, whose direct and indirect real estate investments in 2023 generated a negative return. According to the quarterly data released by the FIN-FSA in autumn 2023, the returns of life and non-life insurance companies’ real estate investments were also the lowest in over ten years.

The weak performance of the real estate market has also been evident in negative valuation adjustments in domestic open real estate funds and increasing redemptions by investors. Amid challenging market conditions, real estate funds have made amendments to their rules by, for example, reducing the frequency of their redemption windows and lengthening the notice period for redemption orders.

Importance of capital adequacy and preparedness is highlighted in times of elevated risks

Despite the turbulence in the operating environment, there were no signs of any extensive and powerful realisation of credit, investment or liquidity risk in the financial sector in 2023. The importance of capital adequacy, strong risk capacity and preparedness is highlighted in times of elevated risks.

The risks to the financial sector are mitigated and hedged by careful risk management and the nature of its investment activities in addition to the sector’s strong loss-bearing capacity and shock resilience, further supported by the buffer requirements imposed by regulation and authorities.

FIN-FSA paid particular attention to real estate risks

The focus areas of supervision in 2023 reflected changes in the operating environment. In its supervision, the FIN-FSA paid particular attention, among other things, to the management of credit and liquidity risk, corporate governance, and operational risks, including cyber risks.

The supervision of credit risks was one of the focus areas in banking supervision. Meanwhile, in the supervision of the insurance and pension sector, particular attention was paid to the valuation and valuation practices regarding real estate investments. The liquidity management and valuation of investment funds have been focus areas of fund supervision in 2019–2023. In addition, a thematic review of stress testing of open real estate funds was carried out in 2023.

According to the FIN-FSA’s findings, there remains room for development in the stress testing of real estate funds, since some of the firms covered by the review had not considered market risks related to the properties and had shortcomings in the reporting of the results to the board of directors. In 2024, the FIN-FSA will continue to monitor the measures taken by the firms to develop stress tests for the liquidity of these funds as well as the state of real estate funds.

A great deal of uncertainty continues to surround economic development, so the risks of the financial sector remain elevated at the beginning of 2024. The focus areas of the FIN-FSA’s future activities will also continue to respond to changes brought about by changes in the operating environment.

¹ Further information on the state of the Finnish economy in 2023 is available in the Bank of Finland’s economic review and forecast (in Finnish). Suomen talous pakkasella – Euro ja talous, https://www.suomenpankki.fi/fi/media-ja-julkaisut/tiedotteet/2023/suomen-talous-on-taantumassa-ja-toipuminen-takkuaa/.