Finnish financial sector’s capital position strong - supervision in 2023 focuses on the risks caused by the uncertain operating environment

The year 2022 was very exceptional. In the second half of the year, the Finnish economy fell into a recession and business and consumer confidence weakened, in some cases even to record low levels. This year looks like being difficult, too. High inflation and the rapid rise in interest rates on loans are decreasing consumers’ disposable income, thereby weakening borrowers’ debt servicing capacity. Risks are also amplified by the record high level of household indebtedness and the large volume of floating-rate loans. Higher interest rates and the weakening economy may also erode demand for financial sector services. Uncertainty exposes financial markets to sharp market fluctuations, and if asset prices decline this may increase the investment losses of supervised entities.

“The financial sector has so far coped with the changes in the operating environment relatively well. However, there is still considerable uncertainty surrounding the outlook for the economy, and therefore financial sector risks remain high. The FIN-FSA's supervisory priorities in 2023 thus respond to these risks caused by changes in the operating environment,” says Tero Kurenmaa, Director General of the Financial Supervisory Authority (FIN-FSA).

The FIN-FSA’s themes for the prudential supervision of banks in 2023 include credit and liquidity risk management, compliance with interest rate risk regulations, and sound governance issues. In addition to assessing the effects of the uncertain investment outlook and inflation, insurance supervision will focus on the soundness of corporate governance, and in capital markets on investor information and conduct, among other things.

Rising interest rates boosted banks’ earnings in an uncertain operating environment

Despite the higher risks in the operating environment, the banking sector’s capital position remained strong in the last quarter of 2022. The sector's Common Equity Tier 1 (CET1) capital ratio was 17.2% (12/2021: 17.8%) and the total capital ratio was 20.6% (12/2021: 21.4%). The banking sector’s operating result was slightly weaker than in the previous year. Strong growth in net interest income was not sufficient to compensate for the trend in other income items, which was weaker than the previous year. On the other hand, the decrease in operating result from the previous year was partly explained by a non-recurring charge in the first quarter of 2022.

The banking sector’s non-performing assets relative to the credit stock remained at a low level. On the other hand, movements of loans between the stages of impairment are signalling a growth in credit risks, particularly in corporate and housing company loans. Finnish banks’ dependence on market funding exposes them to market disruptions and a rise in funding costs. The banking sector’s liquidity ratios exceeded the statutory requirements, but they do not take into account all the risks related to the uncertain market situation.

Employee pension sector’s solvency weakened with developments in the financial markets

The employee pension sector’s return on investment was negative (-5.3%), in line with the general trend in financial markets. The employee pension sector’s solvency ratio declined to 126.9% (12/2021: 136.2%), due to the lower value of investment assets. The change in the value of investment assets was affected, in particular, by the negative return performance of listed shares and bonds. The total return was counterbalanced by the positive return on illiquid investments (e.g. private equity, real estate and hedge fund investments). However, it is possible that, due to the valuation lag, the impact of the weakness in the stock market and the rise in interest rates may be partially reflected in illiquid investments during the current year, 2023. The risk-based solvency position weakened to 1.7 (12/2021: 1.9), due to the decline in solvency capital relative to the solvency limit, as a result of losses in investment activities. The change in the solvency position was dampened by the decrease in the solvency limit, which was due to changes in the size and risk level of investment assets.

Life insurance sector’s solvency performance was excellent

The life insurance sector’s solvency ratio improved significantly in 2022 as a result of the joint effect of the rise in interest rates and the decrease in the solvency capital requirement for market risk, and was 256.1% (12/2021: 192.9%). The rise in market interest rates was reflected as a decrease in technical provisions, which supported the companies’ own funds.

The life insurance sector’s return on investment was -10.0% in 2022, which weakened profitability. Return on both equity and fixed-income investments was negative, but real estate investments continued to generate a stable return. Premiums written decreased and claims paid increased from the previous year. High inflation and the loss-making investment markets had a negative impact on life insurance business.

Non-life insurance sector’s solvency strengthened by steep rise in interest rates

The non-life insurance sector’s solvency ratio strengthened to 301.9% (12/2021: 242.0%) and was 70 percentage points higher than the average since 2016, which marked the introduction of the Solvency II regulation. Solvency was bolstered by the growth in own funds and the decrease in the solvency capital requirement. The amount of own funds grew because as a result of the steep rise in interest rates, the market value of insurance liabilities declined. The solvency capital requirement decreased, because the decline in investment market prices lowered the solvency capital requirement for investments and insurance liabilities.

The return on investment in January-December was negative, -7.1%. Both of the largest investment classes, i.e. fixed-income investments and equity investments, generated a loss. Only real-estate investments generated a profit. Insurance business profitability, excluding the impact of changes in the calculation basis, weakened compared to 2021, which was due to the increase in claims expenses as a result of major losses in the areas of property and business interruption insurance. In addition, claims expenses in motor liability insurance and health insurance rose from the level to which they had sunk during the COVID-19 pandemic.

Appendices

• FIN-FSA website page ‘financial position and risks of supervised entities’ (in Finnish)
• Presentation at the FIN-FSA press conference on 15 March 2023 (PDF, in Finnish)
• Recording of the press conference (in Finnish)