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Household indebtedness and macroprudential supervision

​FIN-FSA annual conference
28 November 2018

Opening remarks by Anneli Tuominen

Good morning everyone! It’s a pleasure to be with you here in Finlandia Hall on this November morning.

The most debated economic policy and research segment among academics and practitioners is currently macroprudential policy.  Therefore, we have also chosen it to be our conference topic this year. I'd like to warmly welcome you to the 7th annual FIN-FSA conference on household indebtedness and macroprudential supervision. 

In my opening remarks, I have three main messages. First, there are fundamental flaws in consumer protection emerged. Second, household indebtedness at record levels - can the trend continue? Third, our current macro pru toolkit is not fit for the purpose.

Fundamental Flaws in consumer protection emerged

I normally listen to the radio on my way to work. During the last year or so, I have heard more and more radio commercials for the so called payday loans. They declare how easy and quick it is to receive a consumer loan “for everyday purposes”. At the same time, the marketing has become more aggressive: people are encouraged to spend more money than they earn by taking a payday loan. It both irritates me and makes me worried. And I am not the only one who is worried, and for good reasons. More and more people are getting into deep trouble because of these seemingly small loans with extremely high effective interest rates.

In Finland, the estimated total amount of consumer loans is around 20 billion euros. That’s approximately 13% of the total household debt stock. At the same time, there are more than 380,000 people with a bad credit record (out of 5.5 million inhabitants) and the trend has been growing for many years.

There are many kinds of consumer loans and I want to stress that not all consumer loans are the same. A significant share of consumer credit is granted by credit institutions and their share of non-performing loans and loan losses has remained moderate.

However, our consumer credit market has changed in recent years. There are various companies and new entrants providing consumer credits and payday loans, for example the so called payday loan companies, peer-to peer lenders, payment institutions providing consumer credits and cross-border credit institutions that are mainly focused to provide unsecured consumer credits online. All of the these financial institutions are not supervised by the FIN-FSA or do not share the same view of responsible lending. 

So far the ways to solve the payday loan problem have been inadequate (at least in Finland). The legislators have set caps on the maximum interest levels. First the rate cap was set to consumer loans under 2000 euros. As a result, the share of 2000+ euros started to increase. Currently the legislators are proposing to extend the rate cap to include all consumer loans (only excluding collateralised housing loans). But there are worries that rate caps might not be an effective tool to solve the problem. What comes to the radio and TV commercials, I am pleased to hear that ministry of justice is now starting to evaluate regulatory alternatives to ensure the appropriateness of marketing consumer credit.

The Finnish consumer protection law states that a lender should grant credit only if and when it believes that the debtor will be able to pay the loan back. How could we make the letter of the consumer protection law more binding? I think we should pay more attention to the assessment of the capacity to repay the loan, and for example use debt-service-to-income as a measure.

Of course, in practice solving the problem is not that clear cut. One main issue is related to data. We'll need more data, such as from a positive credit registry.  But the availability of the data is not enough. The lenders would also need to be obliged to use that data and to document their loan granting procedure. Finally, the procedures need to be supervised with similar tools than other conduct of business regulation and in case of infringement, sanctioned. Last but not least: extending the FIN-FSA's mandate in the supervision of consumer loans is an alternative.     

Household indebtedness at record levels - can the trend continue?

The largest bulk of the debt in most countries is housing debt. This is natural – a house (or an apartment) is the most expensive purchase that an average household makes. During recent decades, total household indebtedness has increased in most countries, including Finland.  Mortgages and in recent years increasingly housing corporation loans (our national peculiarity) have more than doubled since the turn of millennium.

There are several possible explanations for this increase. One is that, globally, interest rates have been on a downward trend since the late 1980s. The time period from the late 1980s to 2008 was called the era of great moderation. During that period, volatility both in GDP growth and inflation declined. At the same time, trend growth accelerated and inflation moderated. As a result, uncertainty diminished, which lowered interest rate risk premia.

The lower the interest rate, other things being equal, the larger debt a household can manage. Similarly, the longer the maturity of the mortgage, the lower are the monthly debt service costs (again other things being equal). When Finland joined the EMU in 1999, both of these changes happened at the same time. Interest rates became lower and more predictable and the maturities became longer. As a result, household debt increased rapidly, both in euros and as a share of income or GDP.

Currently, interest rates are at historically low levels in Finland and in the euro area. Partly this relates to the longer-term fundamentals, partly to the growth-enhancing monetary policy that has been necessary after the deep and long-lasting financial and economic crisis. There are signs that in the not so distant future interest rates might move upwards. In its October meeting, the ECB’s governing council stated that it continues to expect the monetary policy rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

To know exactly when and how much interest rates will increase is not the key factor. But when the two most common mortgage maturities (here in Finland) are 20 and 25 years , it is clear that at least at some point and for some time interest rates will be clearly above their current levels. And as maturities do not have that much scope to lengthen, households should be prepared for a time when a higher share of their income will go to mortgage costs.

There are many ways to prepare for that. One can simply save an extra amount monthly. If this money is needed in the future, it is good to be prepared. And if it is not needed, it would be a positive surprise. And, of course, banks are selling many kinds of products to help to control the risk, like caps and collars.

Another explanation is that Finland is in the middle of a structural change. More and more people are moving either to the local centre cities or to the Helsinki capital region. Urbanization as such is a good thing. But urbanization is also a challenge. In those regions where housing demand increases, house prices tend to increase. When housing demand is higher than housing supply, the right answer would be to increase supply.  Unfortunately, it is very difficult to build a large amount of new housing and at the same time avoid booms and eventually long-lasting bursts.

A busted housing bubble has more severe and long-lasting consequences than a stock market bubble.  Construction has been, is and will be a highly cyclical sector. Recent newspaper headlines have once again reminded us on this fact. 

One example that has worried me and many others for quite some time is the changed ways of utilising housing corporation debt in the marketing of new apartments. Not so long ago, new apartments were sold with zero housing corporation debt. Now even 80% of the price of a new apartment can be housing corporation debt. What is this, except window dressing for marketing reasons?

The FIN-FSA studied last spring the lending criteria and risks associated with credit institutions’ construction-stage financing and housing corporation loans. We found out that the risks have increased due to growth in participations in housing corporate loans and the number of pure investors, a lengthening of repayment-free periods and differentiation of the housing market.  We are concerned about the situation and are directing the focus of supervision and inspections more towards the risks and lending practices of housing corporation loans.

Some banks have already reported revised practices. This is good news, but I do not think it is enough. We need changes in legislation, ways to limit the share of those loans, and ways to limit repayment-free periods. For the sake of our medium-term financial stability.

Our current macroprudential toolkit is not fit for the purpose

Macroprudential supervision is a relatively new policy segment. At its core has been the protection of the financial system: that especially systemically important institutions have enough capital and liquidity against risks and weaker cyclical situations. This as such is a very important and a necessary condition for a stable financial system. But is it sufficient?

The answer is no: it is not sufficient. Economic cycles and financial cycles are interlinked. Even if buffers make institutions more robust, their effect on the pricing of mortgages and thus their demand is very low. To lean against the wind – demand peaks and rapid increase in indebtedness – borrower-based measures are needed.

Claudio, Erik and Niamh will tell us more about their experiences in using various borrower-based tools.  Before that, may I remind you that currently the only measure that affects the borrower in Finland is loan-to-collateral (LTC), which gives a maximum amount of credit that a bank can grant against collateral. 

Why is this not sufficient? One major reason is that during booms assets prices – like house prices – tend to rise faster than income. The increase in house prices also means that the value of collateral increases. A cap relative to income would be more effective.

There are several options for the new tool or tools: debt- or loan-to-income, debt-service-to-income, amortisation rules and maturity caps, to mention just a few. Currently, there is a committee appointed by the Ministry of Finance (and chaired by Leena Mörttinen) whose task is, among other things, to assess possible instruments. Actually, they are assessing all the topics that I have touched on in my opening words: consumer loans, mortgages and housing corporate loans. I am confident Leena and her colleagues will find the expertise and experiences of Claudio, Erik and Niamh useful when doing their work.

There are two main aspects when assessing the most suitable macroprudential tools. One is their effectiveness, the other is their operability. Our current loan-to-collateral tool misses both of those targets. It is a blunt tool: it hits mortgages and housing corporation loans (when a household also needs to take a mortgage). When we tightened that last March, the message from the industry and commentators was “wrong tool used in a wrong way”. As regards operability, it is quite a complicated tool to use. Just have a look of the formula of the LTC! I am confident that while extending and amending our toolkit we can at the same time improve its ease of use. Instead of complex formulas there could be a rule that allows – say – 10% to 15% of mortgages break it. This would give flexibility for the lender side.

Finally, some people seem to think that making macroprudential policy is just one-way street: that the policymaker is only interested in tightening policy, without thinking about the broader consequences for the whole economy. I can confirm to you right now that nothing could be further from the truth.

It is crucial to strike a balance between negative and positive risks. I’d like to think of macroprudential policy as a circle, wherein the stages are financial stability, consumer protection and economic growth. All these elements are crucially important for the policymaker.

The main target of macroprudential policy is to prevent and mitigate risks of disruption to the financial system that have the potential to have serious consequences for the real economy. The recent financial and economic crisis reminded us that there is no economic growth without financial stability. And it reminded us that when a recession is associated with a financial crisis, it is deeper and longer lasting.

I believe that we all agree on how important it is to try to prevent housing and construction bubbles. The disagreements are related to the need for and scope of different measures. As macroprudential policy is a relatively new policy area, a learning process is still ongoing. It will take time – at least one economic cycle – before we can assess with confidence how the tools work and what their impact is. Before that, we need to improve our methods for impact assessments, both those that we make before the decision and those that we make after the decision is made. This will take time and resources, but it will be worth it. Today’s seminar gives us an excellent opportunity to broaden and deepen our understanding of the issue and exchange views on the possible alternatives and their pros and cons. 


To conclude, the three main messages of my remarks have been that, first, consumer loan growth has unwanted side effects. We should have consumer protection in the forefront and pay more attention to the assessment of the capacity to repay the loan. Of course, in practice solving the problem is not that clear cut and there are many issues that need to be considered . One of them is the FIN-FSA's mandate: should it be extended? 

Second, household indebtedness has more than doubled in 20 years. In the early 2000s interest rates became lower and maturities longer. It is unlikely that those trends will continue for ever. Thus, households should prepare themselves for higher rates.

Thirdly, our current macroprudential toolkit is under scrutinity. There are problems both in effectiveness and operability. Macroprudential policy is a new policy area and therefore impact analysis is important.

Now, let me introduce our agenda and our distinguished guests.

Our first speaker is Claudio Raddatz Kiefer from the IMF. In his speech, he will give us an international perspective on household indebtedness, macroprudential policies and financial stability.

After Claudio (and a coffee break) my colleague, the Director General of the Swedish Supervisor Authority, Erik Thedéen, will speak about household indebtedness in Sweden, what has been done there and why. After Erik, Niamh Hallissey from the Bank of Ireland will tell us about the Irish housing cycle, from boom to bust and beyond.

After the lunch break, the Deputy Governor of Bank of Finland, Marja Nykänen, will elaborate on the situation in Finland.

Finally we’ll wrap up the seminar with a panel discussion, which will be chaired by Anni Lassila from the newspaper Helsingin Sanomat.





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