BICRA Highlights

Chart 1

We expect economic growth will only pick up in 2025.  After Finland entered a recession in 2023, we expect the country's GDP will contract further in 2024, before expanding by 1.3%-1.4% over 2025-2026. High inflation and increased financing costs have stifled domestic demand and private investments, while the muted economic outlook for top trading partners has impaired exports. Despite a slight increase in unemployment in 2023, the labor market remains relatively resilient. Overall, we expect credit losses will remain manageable and low in a European comparison, at about 20-25 basis points (bps) over 2024-2025.

Elevated financing costs and housing oversupply have depressed prices.  We expect housing prices, which declined by about 6% in nominal terms in 2023, will remain subdued in 2024. This is mainly due to increased mortgage financing costs and softer consumer confidence. Both weakened housing demand, decreased transaction volumes, and reduced property prices, which already suffered from the excess supply following high construction activity in the past few years. However, we expect the steep decline in prices will end in 2024 as transaction volumes improve. The residential construction will resume only gradually. Overall, we expect a recovery in nominal house price growth in 2025.

We expect Finnish banks' profitability will remain elevated in 2025.  With a large share of lending based on variable rates, Finnish banks have reported record profits in 2023 and the first half of 2024. Even though net interest income has started to decline slightly in 2024, banks' profitability has remained strong in the first half. We expect the banking sector will deliver a still-high return on equity (ROE) of about 12%-13% over 2024-2025, compared with 14.9% in the first half of 2024. Thanks to strong profitability, credit institutions have maintained or even improved capitalization, with an average common equity tier 1 (CET1) ratio of 19.1% and an average total capital ratio of 23.1% as of June 30, 2024. In our view, the banking sector has sound buffers to absorb potential credit losses, even beyond our base case, given banks' strong operating profitability.

Economic And Industry Risk Trends

The economic risk for banks operating in Finland is stable. The economy is slowly recovering and the risks Finnish banks face will be limited over the next two years. In our view, the correction in house prices after the rapid increase in interest rates and muted consumer confidence is virtually over, and we expect a recovery in 2025. Most importantly, we do not expect that house prices will be disconnected from economic fundamentals. Even though we expect credit losses will exceed the cyclical lows over 2024-2025, they will remain manageable and small, compared with other European banks. This is because of Finnish banks' prudent underwriting standards, their focus on collateralized lending, the private sector's sound financial buffers, and Finland's strong social security system.

The industry risk for Finnish banks is stable. Earnings benefited from higher interest rates, and we expect improved returns over the next two years that will enable banks to sustain efficiency-enhancing investments. Thanks to robust capitalization, banks' resilience is unlikely to wane. Despite the sector's reliance on external wholesale funding, which can create confidence sensitivity issues, we think good access to capital markets and the increasing share of covered bond funding partly mitigate the risk. We also note that the deposit base has remained largely stable and continues to be the most important funding source for the wider banking sector.

Economic Risk: 2

Economic resilience: Very low risk and increase in real GDP growth expected for 2025

Finland's economic recession in the first half of 2024 was more protracted and deeper than we initially expected. We have therefore revised down our projections of real growth to -0.4% of GDP, marking a second consecutive year of output contraction. Still, the Finnish economy has begun to recover, and we expect real GDP growth will gradually accelerate as consumption and investments continue to strengthen due to lower inflation, a reduction in financing costs, and strong wage growth. Overall, we project real GDP growth of 1.3%-1.4% over 2025-2026 and per capita GDP of about $54,425 for full-year 2024, indicating that Finland will remain a high-income economy.

Due to weak economic activity and continuing pressures on expenditures, we expect the general government deficit will widen to 3.6% in 2024. The government has announced consolidation measures of €9 billion in total over several years. This, coupled with an economic recovery, should reduce the deficit to about 2% of GDP by 2027 and support Finland's adherence to pan-European fiscal rules. We anticipate increased expenditure control will partly offset rising defense, social, and health expenditures, and support a further reduction in deficits to about 2% of GDP by 2027. This fiscal trajectory would mean that public debt--net of liquid government assets--rises modestly to an average of 51% of GDP through 2027.

Finland's consensus-based policymaking remains proactive and transparent, in our view. The country is equipped with stable and mature institutions and benefits from its membership in the eurozone. Moreover, the rapid accession to full NATO membership in April 2023 has mitigated security risks from the Russia-Ukraine war. The current government's coalition agreement outlines structural reforms that aim to boost economic growth through labor market reforms, address the aging population, and increase competitiveness and productivity.

Table 1

Economic imbalances: Intermediate risk due to an expected recovery in house prices in 2025

House prices in Finland declined moderately from mid-2022 peaks.  Over the course of 2023, residential house prices declined by about 6.4% in nominal terms, with home buyers delaying investment decisions due to higher interest rates. As a result, transaction volumes have been relatively low since the second half of 2022. However, the decline in house prices has largely come to an end in the first half of 2024, with house prices outside of Helsinki even rising slightly between June and August. Transaction volumes and residential construction have also picked up. Overall, we expect house prices will recover in 2025.

For 2025, we expect the housing market will benefit from improved financing conditions for mortgage lending that have started to improve across the eurozone, and an increase in nominal prices as consumer confidence increases. We project real house prices in Finland will be 3.0% lower in 2024 than they were in 2023, translating into a four-year average decline in national house prices of 5.2% in real terms in the capital and major cities. However, we anticipate that house prices will resume growth in real terms in 2025. We think urbanization will continue over the medium to long term, leading to stronger upside potential for house prices in Helsinki and other growth cities.

Chart 2

Private sector credit growth will only pick up in 2025.  Following a contraction in 2023, we expect private sector debt will decline slightly in 2024, before growing modestly in 2025. Since demand for mortgage loans is relatively weak, we think households will continue to use their accumulated savings to offset the increase in debt servicing costs, with some looking to make additional debt repayments. Similarly, we expect the still-muted economic outlook will limit companies' investments and demand for credit in 2024. The construction sector, plagued by high raw material prices and tight financing conditions, continues to face headwinds, with the number of building permits and building starts having declined significantly since 2023. After early signs of improvements in 2024, we expect construction activity and overall business will pick up over the coming two years, with further investments in green energy supporting business activity.

Chart 3

In terms of corporates, the property sector, including residential housing corporations, constitutes about 20% of total lending and 43% of corporate lending. Most of this exposure relates to cash-flow-generating properties that are located predominantly in metropolitan areas and exhibit sound loan-to-value (LTV) ratios. That said, overall investments in the property market remain subdued, with a rolling-12-month transaction volume of a modest €2.5 billion (according to KTI; compared with €7.2 billion in 2022), driven by residential and industrial properties. The office vacancy rates in the Helsinki central business district and the Helsinki metropolitan area have been trending up to 14%-15% in September 2024. The demand from foreign investors will facilitate the property market recovery. External investors continue to dominate the commercial real estate segment (at about 58% of all transactions in 2023 and 45% year to date), which could create vulnerability during economic downturns. Loans to housing cooperations have increased significantly over the past decade, given the demand for renovations and new constructions. While housing cooperations' leverage remains sound, we continue to monitor developments, considering the increase in unsold new apartments.

We expect the Finnish banking sector will remain vulnerable to external debt.  We expect Finland's current account will narrow further in 2024 and remain in a marginal deficit over the next few years as trade flows and primary income flows continue to normalize. That said, financial institutions--predominantly Nordea Bank's pan-Nordic operations--will continue to dominate Finland's external ratios. The economy's external short-term debt remains well above 100% of current account receipts (CARs). Narrow net external debt will remain high and exceed 210% of CARs on average over 2024-2027. Still, we maintain our view that Finland's external profile is stronger than that of European peers, with external assets largely equal to external liabilities.

Table 2

Credit risk in the economy: Higher debt-servicing costs reduce demand

Private sector debt remains moderate, compared with Nordic peers.  Given the low demand for credit, we estimate Finland's household and nonfinancial corporation debt reduced further to 126% of GDP as of year-end 2023, from 143% in 2020. This compares well with a peer average of 182% and is partly explained by Finnish households' tendency to amortize loans. Only one-third of Finns have mortgage loans, with a large part of indebted households holding significant wealth. Additionally, many households have accumulated savings, which improve their financial margins. Households' financial assets were about €388 billion at year-end 2023, resulting in net debt of about 90% of GDP. The financial buffers and the strong social security net underpin our view of households' robust debt servicing capacity, even in times of stress.

In our view, Finnish banks have moderately conservative underwriting standards. Mortgage loans represent about 38% of domestic lending, and we estimate the average LTV ratio across Finnish banks' mortgage books is 55%-60%. Mortgage loans in Finland are actively amortized and had a repayment period of about 25 years as of June 2023. We note that the Finnish Financial Supervisory Authority (FIN-FSA) implemented a legislation that mandates a 30-year maximum maturity for household mortgages in 2023. In December 2023, the regulator also decided to restore the loan cap--meaning the maximum loan-to-collateral ratio for residential mortgage loans other than first-home loans--to its standard level of 90%. For comparison, the loan cap for first-home loans is set at 95%.

Despite the recent sharp rise in interest rates, households' debt servicing capacity remains sound. Finnish mortgages are generally linked to floating rates, and mortgages that are fixed for less than one year account for more than 95% of new mortgages. As a result, debt servicing costs have increased since mid-2022, with interest expenses exceeding 3.0% of disposable income in mid-2024, up from 1.8% in 2022. That said, about one-third of mortgage loans hold interest rate hedges--either a cap or a collar--which somewhat mitigated the negative effects of rising rates. On another positive note, the highest interest expenses tend to fall on average for high-income households, which supports our view of sound debt servicing capacity.

We view the legal framework for creditor protection as effective and predictable.  We think the Finnish payment culture benefits loan repayments and is deeply rooted in a cultural approach to debt reduction, following the housing crisis in the 1990s. Corruption in Finland is very low. The country ranked second in Transparency International's global corruption index for 2023.

Asset quality has weakened slightly since 2023.  Stage 2 and stage 3 loans increased across most institutions, given increased financing costs and the generally weaker economic backdrop. Nonperforming loans (NPLs) also increased to about 1.7% of domestic loans in June 2024, even though their proportion remains small, compared with other European banks. While the rise in NPLs has been particularly evident in the construction industry, which suffered most from the current economic downturn, the housing and consumer credit sectors were also affected.

Table 3

On the back of continuing macroeconomic uncertainties and still elevated financing costs, we forecast that domestic NPLs will remain above cyclical lows, at about 1.7%-1.8% over 2024-2025. We project credit losses of 20-25 bps over 2024-2026, compared with 26 bps in 2023. That said, domestic NPLs and credit losses remain contained, compared with many European banking systems. While we project that credit losses on mortgage loans will be sustained at a low 6-8 bps, additional credit losses will likely result from small and midsize corporates, in particular in the construction sector. We forecast that credit losses on corporates, excluding housing corporations, will be about 30 bps in 2024 and 20 bps in 2025.

As of June 2024, Finland's two major banks continue to hold management overlay provisions beyond the model-based credit losses, with €464 million in the case of Nordea and €105 million in the case of OP Financial Group. These additional buffers support our view that credit losses in the banking system will be moderate over 2024-2026.

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Table 4

Industry Risk: 3

Institutional framework: Finnish regulators collaborate with Nordic peers

In our view, the FIN-FSA is supervising the banking sector in a proactive way and the overall regulation is in line with EU standards. The FIN-FSA oversees national macroprudential decisions. The presence of pan-Nordic banks and the Nordic banking sector's strong interconnectedness requires a close coordination in supervision by Nordic regulators. The FIN-FSA and the resolution authority have proactively strengthened their skills and increased staffing (FIN-FSA now has 230 employees) to supervise and monitor Nordea Bank Abp in cooperation with the ECB's Single Supervisory Mechanism and Single Resolution Board.

In our view, Finnish banks' robust capitalization reflects the prudent requirements. With an average CET1 ratio of 19.1% and a total capital ratio of 23.1% on June 30, 2024, the banking sector demonstrates robust capitalization well above the European average. The FIN-FSA continues to monitor vulnerabilities to ensure capital requirements are adequately calibrated. The reinstated capital buffer for systemically important banks was applied in 2023 and a systemic risk buffer requirement of 1.0% for all Finnish credit institutions came into effect in April 2024. Still, the FIN-FSA has yet to activate the countercyclical buffer. The recent stress test by the European Banking Authority and the FIN-FSA underpins our view of Finnish banks' capital resiliency, even in adverse scenarios.

The Finnish regulator is increasingly focusing on digitalization, cybersecurity, and sustainability. Apart from the diligent monitoring of risks related to the cyclical downturn, Finnish authorities react to emerging trends and remain vigilant of disruptive risks.

Digitalization has spurred the banking sector's investments in technology and innovation for years, and we expect the regulator will closely monitor the trends, analyze their effects on the sector, and develop supervisory practices. Banks and authorities continue cooperating to ensure successful digitalization, for example by using blockchain technology to develop digital end-to-end mortgage products. Large Finnish banks' investments focus on artificial intelligence, which is deployed to improve customer interaction and internal efficiencies.

Increasingly digital banking platforms require cyber security risk management, which remains among the FIN-FSA's main priorities, especially after Finland joined the NATO. The FIN-FSA has recently urged banks to enhance the monitoring of disruptions and suspicious activities--including attempts to damage critical infrastructure--and to notify the FIN-FSA immediately in the case of any abnormal observations.

Finnish banks are increasingly considering environmental, social, and governance (ESG) factors, with the FIN-FSA intensifying its ESG supervision to ensure the effects of climate change are adequately captured and monitored. The regulator has identified climate change as one of the key areas of supervision in its strategy and conducted a major review of the management of climate and environmental risks and related development plans of seven directly supervised credit institutions in 2023. Other focus areas include compliance with international sanctions, general governance, control systems, and financial risks, including the valuation of illiquid assets and the heightened vulnerability of capital markets to shocks. A novel area of focus will be crypto-asset companies' customer due diligence, which the FIN-FSA lists among the thematic priorities for 2024.

We think the Finnish regulator has a good track record of dealing with crises. During the COVID-19 pandemic over 2020-2021, for example, the FIN-FSA relaxed capital requirements to support banks' lending capacity, while the Finnish central bank increased liquidity in the sector.

We consider governance and transparency in Finland's banking system is strong. In our view, meaningful conflicts of interest among the different stakeholders do not exist, and banks' reporting is transparent and timely, in line with international standards and sound compensation practices.

Competitive dynamics: Concentrated and profitable low-risk banking sector

Banks operating in Finland face low-risk competitive dynamics, in our view. In 2023, the banking sector generated about 55% of its earnings from net interest income, mainly from mortgage lending (funded by retail deposits and covered bonds) and corporate lending. These stable earning sources are complemented by net fee income (at about 19% of total income) and net trading and investment income (16%). Large Finnish banks have also demonstrated that they can develop their bancassurance models with leading nonlife and life insurance companies in the market, generating stable insurance income. Other income sources account for about 10% of the total.

Chart 6

Finnish banks' sound core profitability will support their strong loss-absorbing capacity.  High interest income has boosted Finnish banks' earnings, leading to a reported ROE of 13.8% in 2023, compared with 9.6% at year-end 2022. Historically, Finnish banks' profitability fell short of peers', particularly when interest rates were low. This reflected the low lending margins and high share of cooperative and savings banks in Finland, which accounted for about 44% of domestic deposits and 46% of housing loans to Finnish households in 2023. Cooperative and savings banks generally focus on stable returns (after member benefits), high capitalization, and standard banking products for member or owner customers. Even though the ECB's rate cuts have reduced Finnish banks' net interest income, profitability has remained strong, with a reported ROE of 14.9% in the first half of 2024. Overall, we project a still-elevated ROE of 12.0%-13.0% over 2024-2025, underpinned by banks' sound revenue generation and mix, efficient operations, and moderate credit losses.

Even though Finnish banks are already at the forefront of digitalization in Europe, we anticipate that the banking sector's operating efficiency--the cost-to-income ratio stood at 43.5% in the first half of 2024 and 44.1% in 2023--will remain strong. This is because of improved profitability over the past two years and the sector's continuous investments in automation and digitalization bearing fruit. Banks--including small and midsize institutions--have announced that they will increase their IT staff, digitalization budgets, and investments in AI. Incumbents have also embraced collaborations with financial technology companies, for example through accelerator models. This will lead to more opportunities for growth and data access. We also note that Finnish banks are among the first in Europe to use blockchain technology for property transactions.

Three large domestic banks dominate the Finnish banking sector. Overall, the market is highly concentrated. Yet we think that it will remain stable and that the risk of tech disruption remains limited. The three largest banking groups--OP Financial Group, Nordea Bank, and Danske Bank--dominate almost 80% of the market. The regional franchises of small and midsize commercial banks, as well as amalgamations of savings and cooperative banks, are sound. The high interconnectedness among the Nordic banking sectors means Finnish banks' capacity to extend credit could be affected by financial difficulties at large pan-Nordic parent groups' non-Finnish operations.

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Table 5

Systemwide funding: Stable deposits and covered bond funding bridge the funding gap

Banks in Finland face moderate funding risks, despite an increased deposit base.  We project Finnish banks' ratio of loans to core customer deposits will remain high in a European context, at about 170%-180% through 2026. This figure is slightly lower than that of Nordic peers as Finnish households accumulate a higher share of savings in deposits instead of equities and mutual funds, which are more common in other Nordic countries. The overall deposit stock has started to decline since year-end 2022, with households reducing their balances on overnight deposit accounts to €70 billion in September 2024. However, this trend has been counterbalanced by the growing popularity of fixed-term deposits with an agreed maturity (€15 billion) and investment deposits (€29 billion). Since the first quarter of 2024, the banking sector's overall deposit stock has resumed growth, with reported systemwide domestic deposits at €199 billion as of Sept. 30, 2024.

We see the growing dependence on external wholesale funding as a key weakness.  The funding gap is mainly met by issuances of covered bonds, unsecured debt, and commercial paper. We note positively that covered bond issuances extended the maturity of Finnish banks' funding profile to cover the mortgage loan books and improved Finnish mortgage lenders' asset liability management. Adjusted for covered bond issuances, we estimate the ratio of loans to funding--which is mainly derived from deposits and covered bonds--is about 135%. Over the past few years, Finnish banks have increasingly used wholesale funding, particularly at short maturities, and issued more than €180 billion in short- and long-term debt at year-end 2023. This constituted 66% of GDP, compared with 62% at year-end 2018, and was primarily driven by the re-domiciliation of Nordea to Finland. Although smaller banks and banking groups have also started to issue covered bonds, the three largest financial institutions account for almost all the system's external funding, with domestic, Nordic, and eurozone investors holding a major part of this debt. Overall, however, most Finnish credit institutions' funding remains dependent on deposits, which have historically been a stable funding source.

Finnish nonfinancial corporates and banks have access to euro-denominated issues. As demonstrated during the recent episode of market volatility, this is underpinned by the frequent issuance of unsecured and secured debt instruments, with medium-term maturities of three to six years.

We think the government and the Bank of Finland can support banks' funding needs.  As a eurozone member, the Bank of Finland operates under the ECB. We think the central bank and the ECB have considerable capacity to support domestic banks' funding and liquidity needs in times of stress, which provides an uplift to our overall systemwide funding assessment.

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Table 7

In our view, the Finnish banking system's growth prospects are closely linked to the overall performance of the small, open economy. Despite the continuous urbanization and the recent correction in house prices, we think Finland's banking sector is less exposed to economic imbalances in the housing market than those of Nordic peers. Nevertheless, external weaknesses--in particular a high level of external debt--could pose a risk, in our view.

Finnish banks increasingly rely on wholesale funding, similar to Nordic peers. Yet this is mitigated by their stable access to the covered bond market. We consider competitive dynamics for banks in Finland are somewhat less risky than they are for many peers. This is mainly due to Finland's concentrated banking sector, which is characterized by the high market share of cooperative and mutual banking groups, as well as banks' sound core profitability and their advanced digital agenda.

Government Support

We classify Finnish government support for banks as uncertain and consider the resolution regime is effective. The EU's Bank Recovery and Resolution Directive, including bail-in powers, was fully implemented in Finland in 2015. The resolution act provides the Financial Stability Authority with resolution powers and bail-in tools. The authority has settled on bank-specific resolution plans, including minimum requirements for own funds and eligible liabilities, for all institutions that are considered systemically important.

Table 8

Related Criteria

• Banking Industry Country Risk Assessment Methodology And Assumptions, Dec. 9, 2021
• Financial Institutions Rating Methodology, Dec. 9, 2021
• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Sovereign Rating Methodology, Dec. 18, 2017

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• SLIDES: Nordic Banks In 2024 Ploughing On Through Tough Terrain, Feb. 7, 2024