13 November 2012

Bank of Finland: The crisis and the regulatory initiatives it triggered will reshape banking

The euro area debt crisis and ongoing initiatives to remedy the defects detected in banking regulation will strongly reshape the operating environment of European banks, according to the Bank of Finland's Financial Market Report 2/2012.

In countries hit by the crisis, the fate of banks and government finances are still strongly intertwined. Economic activity and financing conditions have significantly diverged within the euro area, which is reflected in large differences between countries in terms of international capital flows, bank funding and financial intermediation by the banks. Banks’ balance sheets are increasingly tied to securing funding, as market-based unsecured funding has become more difficult, especially in countries afflicted by the debt crisis.

The Finnish banking sector’s capital adequacy has remained strong during the crisis, with banks retaining their ability to ensure financial intermediation. The long-sustained exceptionally low level of interest rates will, however, erode banking profitability, as the bulk of loans granted by banks in Finland are tied to variable interest rates and net interest income accounts for a significant share of banks’ total income.

The global financial crisis that began in 2008 revealed a number of defects in banking regulation. Accordingly, efforts are being made to stave off future crises by improving banks’ capacity to absorb losses, reining in excessive risk-taking by individual banks and increasing the powers of the authorities to address financial market risks at a sufficiently early stage. Important EU-level initiatives include the overhaul of capital adequacy and liquidity requirements for banks (Basel III) and a ‘banking union’ initiative concerning the development of banking supervision, bank recovery and resolution regimes, and deposit guarantee schemes.

In addition to the regulatory changes currently under way, there is a need for structural reforms in the banking sector, for which the High-level Expert Group appointed by the European Commission submitted its proposal in early October. The most important of the Group’s proposals is the separation of proprietary and other high-risk trading from basic banking within banking groups.

In Finland, it is proposed that the Financial Supervisory Authority (FIN-FSA) be provided with new tools to ward off risks threatening the stability of the financial system as a whole. A working group tasked with considering the organisation of macro-prudential supervision at the national level suggests that, whenever necessary, FIN-FSA could curb excessive lending for house purchase by limiting the size of new housing loans and could modify the additional capital requirements for banks in order to reduce the procyclicality of bank lending. Prior to making such decisions, FIN-FSA would be required to consult the Bank of Finland and other financial market authorities.

The European financial system is bound together not only by regulation but also by a common infrastructure. The project of euro area central banks to offer a single technical platform for securities settlement is progressing according to schedule. The TARGET2-Securities system (T2S) will be widely introduced by national central securities depositories from summer 2015 onwards. In Finland, Euroclear Finland is committed to launching T2S in the latter half of 2016.

Press release

Financial Market Report 2/2012 (in Finnish)

© Suomen Pankki - Finlands Bank