Financial position and risks of supervised entities 1/2013: Profitability of traditional business operations strained
Overall, the Finnish financial sector developed positively in 2012. The profitability and capital position of both the banking and insurance sectors strengthened. ‘Favourable overall results, however, conceal a weakening of profitability in traditional business operations and differences in individual market participants’ profitability. The low level of interest rates and sluggish economic growth pose a challenge to smaller banks, in particular, for whom net interest income is the key source of income,’ notes Anneli Tuominen, Director General.
Low interest rates have eroded banks’ net interest income
In the banking sector, growth in operating profits came from increased returns from securities trading and investment. These earnings are concentrated in the largest banks. By contrast, net interest income contracted, with its share already declining to less than half of the banking sector’s net income. In euro terms, net interest income has diminished by about a quarter since its peak in 2008. The profitability of banks dependent on net interest income has accordingly weakened.
The challenging operating environment and costs stemming from regulation have put pressure on banks to raise their customer margins and fees. Agreements made with customers must nevertheless be respected. For example, making an extra loan repayment or exchanging collaterals of at least the same value does not, as such, provide grounds for increasing the lending margin.
Capital positions and liquidity remained good
Finnish banks’ capital buffer has remained unchanged. The whole sector’s capital adequacy ratios improved, as risk-weighted assets declined, in relative terms, by more than own funds. The capital adequacy ratio at the end of 2012 was 17.0% (31 December 2011: 14.2%). The Core Tier 1 capital ratio was 15.5% (31 December 2011: 13.1%). The liquidity position of Finnish banks is strong, and they have maintained their safe-haven status in international markets.
Employee pension institutions’ solvency remained virtually unchanged. The ratio of the solvency margin to the risk-based solvency limit remained at 2.5 throughout the year (31 December 2011: 2.6). Investments of employee pension institutions yielded an average return of 8.4%.
Life insurance companies’ risk-based solvency position improved from 2.4 at the end of 2011 to 3.0, and that of non-life insurance companies from 1.8 to 2.1. The average return on investment of life insurance companies in 2012 was 9.7%. The profitability of non-life insurance companies was better than in the previous year, owing to a lower level of claims incurred.
Risk outlook dominated by continuing low interest rate level and weakening economic growth
The most important sources of risk for banks are the continuation of problems due to the European debt crisis and the low level of interest rates, as well as the slowing of economic growth. Slower economic growth is likely to increase the amount of non-performing loans from the current low levels.
Yields on debt instruments in 2012 were boosted by falling interest rates and narrowing credit risk margins. As these developments are not likely to continue, the low level of interest rates will begin to weigh on the profitability and solvency of life insurance companies, in particular. ‘However, Finnish life insurance companies are already well prepared for the effects of low interest rates, as contracts with guaranteed returns account for only about a half of technical provisions and about a quarter of premiums written,’ notes Jukka Vesala, Deputy Director General.
For further information, please contact
- Anneli Tuominen, Director General, tel. +358 10 831 5300
- Jukka Vesala, Deputy Director General, tel. +358 10 831 5374
- Financial position and risks of supervised entities 1/2013 (in Finnish, pdf)
- FIN-FSA's letter to credit institutions (in Finnish, pdf)