IMF - Finland: Financial Sector Assessment Program—Technical Note on Crisis Management and Bank Resolution

See my Financial Sector Assessment Program (FSAP) report on behalf of the International Monetary Fund on the Finnish financial safety net, crisis management and resolution arrangements for the financial sector published in February 2023.

There have been major structural changes in the Finnish financial sector since the last FSAP in 2016. Nordea’s re-domiciliation in 2018 to Finland has increased the size of banking sector assets as a percentage of GDP from 250 to 350 percent. Nordea’s move also further deepens Finland’s direct exposure to the stability of the other Nordic-Baltic countries, particularly Sweden. Cross-border exposures to Denmark, Norway, and Sweden are now 80 percent of total cross-border exposures. Among Finnish banks, Nordea holds 74 percent of its assets in these three countries.

Despite these structural changes to the Finnish financial system, the Finnish financial safety net and crisis management arrangements rest on sound statutory foundations. As Finland is part of the Euro Area framework, the resolvability of Significant (SIs) and Less Significant (LSIs) Finnish institutions have improved their compliance with the European Union’s variant of the Financial Stability Board’s loss-absorbing capacity requirements, known as Minimum Requirement for Own Funds and Eligible Liabilities (“MREL”). At a national level, the Finnish authorities have also improved internal and inter-authority crisis preparedness. Reflecting the greater level of interconnectedness in the Nordic-Baltic region, in 2018, the Finnish authorities signed an updated MoU with Nordic-Baltic authorities focused on improving coordination with respect to managing crises in the regional financial system.

Notwithstanding this progress in Finland, recent crises around the world and heightened geopolitical tensions have reinforced the need for full operational readiness in the Finnish authorities’ crisis management arrangements. There is still room for improvement in key areas, including interagency crisis preparedness, LSI resolvability, operational readiness to implement resolution actions, and central bank crisis liquidity support arrangements. This is particularly the case for the Finnish Financial Stability Authority (FFSA) and Bank of Finland (BoF) given their responsibilities for implementing resolution actions and as lenders of last resort under the preferred resolution strategy for Finnish SIs and LSIs. The report makes 15 recommendations with some of the main themes summarised below:

1. Crisis coordination arrangements - The authorities should increase the centralization of cross-authority crisis cooperation and coordination in the Crisis Management Cooperation Group. It should have responsibilities for coordinating cross-authority preparations for, and management of, future crises (but not decision-making). There is a high level of interdependence related to the sequencing of the respective independent actions that each authority needs to take as firms begin to experience stress or fail. As a result, the new crisis management cooperation group should also play a role in coordinating the authorities’ work to formalize respective internal crisis management practices so that they best support coordinated authority action under agreed crisis management plans. It should undertake regular monitoring to ensure that resources dedicated to crisis management are commensurate with specific statutory functions.

2. Resolvability of financial institutions - Under Single Resolution Board (SRB)’s guidelines, SIs and LSIs are expected to have removed the remaining barriers to resolvability by January 1, 2024. This includes valuation and funding in resolution reporting capabilities. The FFSA has defined expectations for firms to comply based on Single Resolution Board (SRB) and European Banking Authority (EBA) resolvability policy and a requirement to self-assess compliance. Based on the experience gathered with SIs, FFSA applies the SRB’s heatmap methodology assessing LSI resolvability. To support consistent evaluation of firm-specific actions to improve resolvability, the FFSA should develop a resolvability scoring framework (or adopt one if developed by the Single Resolution Board) for Finnish LSIs ahead of 2024. Such a framework should capture examples of good and bad practice in the firm’s implementation of resolvability expectations. It will also support the prioritization of FFSA verification of firm-specific capabilities and ongoing maintenance of resolvability capabilities. The FFSA should ensure that the resolution plans for SIs and LSI with an amalgamation structure can be implemented at speed, and with certainty, over the resolution weekend while ensuring SRM resolvability expectations are tailored to take account of their legal entity structure.

3. Operationalising resolution tools and defining resolution mechanics - The FFSA should develop and publish its resolution mechanics to use the resolution tools, prioritizing the bail-in tool initially. This published bail-in mechanic should define the FFSA’s approach to key policy choices related to valuation timelines, treatment of resolved bank shares, issuance of new shares or interim instruments, and approach to ensuring compliance with change in control and other regulatory requirements under the European prospectus directive. The FFSA should explain to host authorities of Finnish headquartered banks how the existing crisis management and resolution framework interacts with the new tools as failure to do so may trigger a fragmented crisis response or incentivize pre-emptive host actions in a crisis.

4. Backstop liquidity arrangements - The BoF should ensure that its Emergency Liquidity Assistance (ELA) and funding in resolution lending capabilities are fully operational. Building on existing internal ELA policies and procedures, the BoF should further develop its internal preparedness to support lending to failed banks whose solvency and viability has been restored through the application of resolution tools and the development of a credible restructuring plan. This preparedness should include defining internal collateral haircuts and pricing assumptions for crisis lending as well as regularly testing its ELA lending arrangements with its counterparties. With the FFSA, the BoF should formalize a non-firm specific approach to addressing liquidity needs for Finnish banks in resolution should they arise so that reporting and operational issues can be identified as part of planning.

5. On deposit guarantee arrangements, the FSSA Deposit Guarantee Fund (DGF) should ensure that it has sufficient funds under its direct control to ensure its financial autonomy and minimize its dependency on borrowing from banks to support a payout. A well-funded and backstopped DGF is important both to support rapid payout of covered deposits if required but also given its role in contributing to the cost of resolution actions. Ensuring the DGF can deploy its funds to support resolution costs is particularly important for situations where banks are not able to issue MREL due to prolonged loss of access to wholesale markets or for firms that do not have sufficient MREL resources. The FFSA should outline how the counterfactual insolvency valuation analysis as a basis for assessing the amount of DGF funds that it could contribute would be done. The FFSA should take a prudent approach and ensure that its prefunded DGF, and its policy advice on the appropriate target level ensures it is sufficient for a range of crisis scenarios (e.g., deposit payouts in the case of a concurrent failure of several mid-size LSIs).

The report is based on extensive discussions with officials and senior staff of the Finnish Ministry of Finance (MoF), BoF, Finnish Financial Supervisory Authority (FIN-FSA), FFSA and with private-sector stakeholders, including banks and the wider industry. It was a pleasure working with them, and I appreciated their excellent engagement, open dialogue, and warm hospitality throughout the FSAP process, which contributed to this report and my recommendations.