Stable financial system forecast despite recession

Finland’s financial system has remained stable despite the recession in the economy, according to the assessment of Finland’s financial stability published by the Bank of Finland on Tuesday.

The risks have been controlled particularly as a result of the long-term improvements made in financial regulation and supervision and the macroprudential policy measures taken.

Russia’s war in Ukraine, the conflict in Gaza and trade restrictions between different countries could create disruptions in the global economy and financial system.

“The resilience of Finland’s financial system has remained robust. Geopolitical tensions have increased, and this could create new threats to financial stability,” said Bank of Finland Deputy Governor Marja Nykänen.

The financial stability assessment noted that the standstill in the housing and real estate markets and the considerable sensitivity to interest rate movements are increasing the risks in Finland’s financial system.

Prices of existing homes have decreased substantially, housing sales have fallen and the construction of new dwellings has virtually halted.

Bankruptcies among construction industry companies have increased, and banks’ credit risks on loans to the construction sector have grown. At the same time, household indebtedness has decreased, which has eased the risks.

If interest rates are cut and the economy recovers as anticipated, this will bolster the stability of Finland’s financial system.

On the other hand, the risks faced by banks and by residential property and real estate investors could increase if housing and real estate sales do not pick up.

There will also be new and unforeseeable threats associated with digitalisation and climate change, and these could undermine financial stability in both the short and the long term.

Digitalisation in the financial sector brings many opportunities but also increases risks regarding the transmission of disinformation and information influencing. The risks to financial stability arising from climate change and biodiversity loss are in part still difficult to assess.

Preparations should be made for dealing with new risks brought by a more challenging operating environment.

“Expanding or reducing financial market regulation cannot in itself be the objective. Regulation must be taken forward on the basis of careful planning. Financial regulation should anticipate changes in the operating environment so that we are not simply fighting old crises,” said Nykänen.

The ability of banks and borrowers to withstand economic shocks must be strengthened. A diversity of macroprudential policy measures will reinforce the resilience of banks and borrowers, enabling better preparedness for fluctuations in housing market activity and housing prices. Trust in the resilience and reliability of the financial system will be enhanced through further preparation for liquidity and cyber risks.

European companies need more diversified ways of financing their investments and creating a foundation for growth in their business. The European Union would benefit from a single and well-functioning capital market.

“European businesses are too dependent on bank financing. The EU needs a capital markets union so that Europe can continue to be competitive in the face of pressures from other major economic powers. A strong European economy is the best protection against disruptions to the financial system,” Nykänen added.