Europe has woken up to a new reality after Russia’s invasion of Ukraine. At the same time, hybrid influence and cyber attacks are an increasingly serious threat to society. Many uncertainties are also impacting the global economic outlook. Record-high government and household indebtedness is a cause for concern, and accelerating inflation, rising interest rates and the tense geopolitical situation are unsettling markets, while medium-term economic growth figures are being revised downwards. Hopefully, the pandemic will be overcome, but there is no certainty about this and new variants raise fears. Meanwhile, listed companies and the financial sector are reporting record results and the unemployment rate has returned to its pre-pandemic level. The economic recovery has been aided by various government support measures and the stimulative monetary policy of central banks. The need to strike a balance between recovery and tackling high inflation has been particularly evident in recent comments of the US Federal Reserve. In this uncertain situation, the importance of good and sound risk management is – once again – underlined in the financial sector, whether it concerns the credit or market risks of banks, the risk management of employee pension companies’ investment activities or cyber risk preparedness.

Finland’s financial sector still in good shape, credit risk management is central

Despite the pandemic, Finland’s financial sector has fared well to date. The results of many actors are at record levels and the capital adequacy of the banking sector is better than the EU average. At the start of the coronavirus crisis, Finnish banks granted payment holidays to their customers and were able to provide finance to companies and households during the pandemic. This was partly due to the regulatory flexibility granted by supervisors and the fact that, due to tightened banking regulations, banks’ capital adequacy ratios were at a higher level than in previous crises.

So far, the non-performing assets of Finnish banks are among the lowest in the EU, although a slight upward movement can be seen with regard to household loans. At the same time, however, the low level of non-performing loans raises concerns about whether all banks in Finland and elsewhere in Europe are conscientiously complying with the regulatory framework for credit risk management.

Basel III agreement important, reform will also increase stability in Finland

From the standpoint of the crisis resilience of the European banking sector, it would be important to reach agreement on globally agreed rules for the Basel III reform. In Finland, the regulatory package is still under discussion, as the overall risk weight floor of the reform particularly impacts those banks that use internal models for capital adequacy (so-called IRBA banks) and have a large number of low-risk residential mortgage loans on their balance sheets. According to our calculations, the proposed model will increase the capital requirements of Finnish banks by approximately 15%.

Personally, I would have liked an outcome that takes risks better into account, but I still do not see a particular problem with the proposed model for the lending capacity of the Finnish banking sector. The capital requirements imposed on banks in Finland as a result of the regulatory reforms following the financial crisis have not had a directly perceptible effect on the interest rates on bank loans. Neither, therefore, have they had a dampening effect on credit demand. The margins on residential mortgage loans granted by Finnish banks have long been among the lowest in the EU. A profitable, well-managed and well-capitalised banking sector will be able to provide finance to households and businesses also in the future. Financial stability is a prerequisite for sustainable economic growth.

Further harmonisation needed in EU on use of macroprudential buffers and definitions of demand-based instruments

In addition to microprudential supervision, macroprudential measures contribute to ensuring financial stability. The European Commission is currently consulting its stakeholders on how to develop the macroprudential framework. There are many aspects to this, such as increasing the buffers that can be released in normal circumstances and more flexible use of buffers in economic upswings and downturns. It would also be important to strengthen both the role of the European Banking Authority (EBA) in harmonising regulations and the role of the European Systemic Risk Board (ESRB) in deciding on buffers, as national macroprudential authorities apply requirements based on their own situation, and preconditions for buffer requirements are not sufficiently harmonised at the EU level. There are also many discrepancies in the practices of different countries.

Another shortcoming is lack of harmonisation of the definitions and use of borrower-based instruments (e.g. debt-to-income ceiling). The ESRB and the International Monetary Fund (IMF), among others, have recommended strengthening the macroprudential toolkit with these borrower-based instruments. Indeed, the views of expert organisations are important because political decision-makers are rather reluctant to adopt borrower-based instruments at the national level. In practice, it is households that bear the risk of weaker-than-expected economic development, as banks have incurred hardly any credit losses from residential mortgage loans.

The third area where structural changes would be urgently needed is the extension of macroprudential instruments to non-banking actors, such as funds.

EU supervisor for major insurance companies?

ECB-led banking supervision in the euro area has focused strongly in recent years on the fair and equal treatment of banks. For example, a separate function that makes ex-post assessments of the consistency of the supervisory review and evaluation process (SREP) has been established within the ECB. SREP assessments conducted with rigorous screening determine, in turn, the level of discretionary capital requirements and guidance. In the insurance sector, too, the European Insurance and Occupational Pensions Authority (EIOPA) is working to harmonise supervisory practices. EIOPA is not a supervisor, however, and does not have supervisory powers. It would therefore be appropriate to examine whether an EU-level supervisory authority should also be set up to supervise the largest insurance companies.

Climate risk preparedness must be improved in banking and insurance sectors

Both banking and insurance supervisors critically assess whether supervised entities’ preparedness for climate and sustainability risks (ESG risks) is sufficient. The means employed are self-assessments, supervisor assessments, and macro- and micro-level stress tests. According to the macro-level stress test published by the ECB last September, the financial sector will suffer significant losses if it does not take climate change into account in its operations. An ECB micro-level stress test is currently under way and its results will be published in July. Climate change must therefore be taken into account in financial sector actors’ risk management, business models, disclosure requirements, solvency and long-term strategy. In the FIN-FSA, preparedness for climate change has been one of the strategic priorities. This has been reflected both in the amount of training and supervision releases on the issue and in the oversight of sustainable finance disclosure obligations, particularly in fund products. The importance of monitoring disclosure obligations is underlined by the fact that investors' interest in ESG products has increased the risk of greenwashing.

Cyber threats must be taken seriously

In terms of operational risks, the number of cyber attacks, in particular, has increased during the pandemic. According to the Bank for International Settlements (BIS), in the early stages of the pandemic, the financial sector was the target of most cyber attacks, immediately after the health sector. Cyber attacks have become a major threat to the functioning of society. To date, cyber attacks in the financial sector have been mainly denial-of-service attacks and they have failed to corrupt the systems of financial sector actors. Cyber attacks may increasingly be state-sponsored or launched by organised crime. We must respond to threats more seriously, and preparedness must be commensurate with this. The EU is also preparing new legislation (the DORA Directive), which aims to strengthen the operational resilience of actors and the system. In addition, the European Supervisory Authorities, together with the ESRB, have set up a coordination network to mitigate systemic risks arising from cross-border cyber attacks. The importance of these measures and of the precautions taken by individual supervised entities cannot be overstated. In Finland, the issue of the financial sector’s preparedness for emergencies and serious incidents must also be resolved without delay. Serious hybrid and cyber attacks may otherwise even paralyse the financial sector, including payment services, and in this way jeopardise society’s ability to function.

EU supervisor for money laundering prevention – risk-based regulation and supervision should also be strengthened

Work to prevent money laundering and terrorist financing (AML/CFT) also aims to reduce criminal abuse in the financial sector. AML requirements have tightened significantly in recent years. The FIN-FSA has bolstered its activities in this sector in both regulation and supervision. National supervision is not sufficient, however, and experience has shown that there are qualitative differences in supervisors’ actions. The proposal to establish an EU-wide Anti-Money Laundering Authority (AMLA) must also continue to be supported. It should base its work on the good experiences gained from the ECB’s banking supervision. The AMLA would supervise the largest financial sector actors, harmonise regulations and coordinate the activities of national supervisors.

In the future, regulations, supervised entities’ measures and supervision should become more risk-based in order to receive better value for the euros spent in preventing money laundering and terrorist financing, i.e. so that it would be possible with the investments made to block the movement of criminal proceeds better. It would also be valuable to carry out impact assessments of new regulations, to evaluate the benefits of the regulations – in particular, the detection of significant cases of money laundering vis-à-vis the inconvenience caused to low-risk customers.

Pension companies’ role in implementing social security restricts their freedom of action

The role of pension companies in society is one of the enduring themes of Finnish social discussion. Pension companies are important implementers of social security. Their activities – with the exception of investment activities – are non-economic in nature. It is worth remembering that the waiver granted by the EU to Finnish pension companies from complying with the Life Insurance Directive requires that this role be maintained. Employee pension insurance actors should also continue to remember the nature of the industry and its regulatory structures and obligations.

The willingness of pension companies to increase investment risk also presents its own challenges. The joint and several liability of pension companies requires strict risk management and an investment policy appropriate for implementation of the occupational pension scheme. Under no circumstances should joint and several liability result in moral hazard. Achieving the target rate of return, moreover, should not lead to excessive risk-taking. An examination of solvency regulations from different perspectives on the basis of a transparent expert discussion would be appropriate.

Increased need for financial literacy

Investing in shares has grown in popularity, particularly among young investors. This is a positive development. At the same time, however, the risks of investing have grown. The year under review saw a large number of listings, including the first SPACs (Special Purpose Acquisition Companies). At the same time, speculative investments in both meme stocks and cryptocurrencies increased. Authorities warned of the risks of exotic instruments and non-transparent pricing as they waited for further regulation of crypto assets. Heightened market uncertainty, inflation prospects, concerns about rising interest rates and the prolongation of the pandemic, and in particular the war in Europe, have at least temporarily lowered asset values. New investors have learned a lesson on the risks of investing.

As the number of retail investors has grown, so has the need for reliable and easy-to-understand investor information. Information should reach new investors through different channels. The Bank of Finland’s proposal for a national financial literacy strategy aims to make Finns the most financially literate people in the world by 2030. I wholeheartedly support this goal. In achieving this, schools will also have a more pronounced role in teaching the fundamentals of financial literacy.

Challenges for the FIN-FSA

In the spring, we commissioned an external consulting firm to evaluate our operations in comparison with our peer supervisors. The evaluation described our strengths but also areas for development. In the consultant’s view, the latter were mostly related to a lack of resources. In the last 3–5 years in particular, our peers have increased their capacity to meet the challenges of stricter and more complex regulations and the changing operating environment. It turned out that the FIN-FSA’s costs are around 30% lower than those of our peers, despite the fact that the FIN-FSA’s resources have also been increased by around a third over the last five years. When preparing a future strategy, the FIN-FSA should consider its risk appetite: shortcomings in resourcing are also easily reflected in the outcomes of supervisory work.

In order to protect the health of our staff during the pandemic, we at the FIN-FSA have been teleworking for nearly two years. While teleworking has the potential to improve work efficiency, it may reduce the sense of community and the team spirit of the workplace. In these circumstances, it is gratifying that the result of the personnel survey of all FIN-FSA employees had developed positively and was at a satisfactory level (A+) and that the result of a stakeholder survey we commissioned had moved in a positive direction and was at a good level. There is no reason for complacency, however; a good atmosphere must also be maintained in the future, and our activities and efficiency must be developed further. Boosting efficiency requires clear and standardised processes, tight tracking of goals, modern tools, easy access to data, and use of robotics and artificial intelligence. To enhance our operational efficiency, it is also important to successfully complete the digitisation projects we have started.

For a supervisor, independence is a prerequisite for credibility

Last year, the European Supervisory Authorities conducted a study on the independence of national supervisors. Independence includes, in particular, financial and operational independence and the avoidance of conflicts of interest. Personally, I feel that the cornerstones of the credibility of the supervisor are independence and a high level of professionalism, combined with adequate resources. Independence means independence from supervised entities, political decision-makers, various stakeholders, lobbyists, media. Without independence, there is no credibility. I also want to leave this message for my successor.

In conclusion

During the year under review, in addition to my own work, I served for seven months as Interim Chair of the European Securities and Markets Authority (ESMA). The experience shed light on the multidimensional nature of European decision-making and the demanding role of the Authority in preparing European regulations and harmonising supervisory practices. Without the selfless support of ESMA’s staff, I would not have been able to perform my duties. Many thanks to them.

This is my final Director General’s Review. I have served the FIN-FSA for well over twenty years. It has been a rich and fulfilling time, and few are the days that I would have given away. The operating environment has changed enormously during these years, as have the competence requirements. The lessons of the financial crisis are reflected both in regulations and new supervisory structures and in the depth of supervision. The ECB in the euro area and the FIN-FSA in Finland have both redeemed their places. I am not going to speculate on how the business models and structures of the financial sector will change in the future, how much digitalisation, new actors and increased use of data will affect service provision and competition between different players. The supervisor must, in any case, be prepared for all kinds of changes.

I have had the opportunity to do socially important work in support of the confidence felt towards the financial sector, safeguarding the interests of the insured, and the stability of the financial sector. I have been able to serve among professionals in a working community with high ethical standards and an agreeable, informal working atmosphere. For that, FIN-FSA employees, I thank you all.

In Helsinki on 8 March 2021

Anneli Tuominen