Finland: Financial Sector Assessment Program-Technical Note on Systemic Risk Analysis and Stress Testing

FINLAND IMFCountryReportNo.23/61 February2023 FINANCIALSECTORASSESSMENTPROGRAM TECHNICALNOTEONSYSTEMICRISKANALYSISANDSTRESSTESTING ThisTechnicalNoteonSystemicRiskAnalysisandStressTestingfortheFinlandFSAPwaspreparedbyastaffteamoftheInternationalMonetaryFundasbackgrounddocumentationfortheperiodicconsultationwiththemembercountry.ItisbasedontheinformationavailableatthetimeitwascompletedonJanuary20,2023. Copiesofthisreportareavailabletothepublicfrom InternationalMonetaryFundPublicationServicesPOBox92780Washington,D.C.20090Telephone:(202)623-7430Fax:(202)623-7201 E-mail:publications@imf.orgWeb:http://www.imf.orgPrice:$18.00perprintedcopy InternationalMonetaryFundWashington,D.C. ©2023InternationalMonetaryFund FINLAND January20,2023 FINANCIALSYSTEMASSESMENTPROGRAM TECHNICALNOTE SYSTEMICRISKANALYSISANDSTRESSTESTING ThisreportisbasedontheworkoftheFinancialSectorAssessmentProgram(FSAP)missionthatvisitedFinlandinSeptember2022.TheFSAPfindingswerediscussedwiththeauthoritiesduringtheArticleIVconsultationmissioninconsultationmissioninSeptember2022(thecloseoftheFSAP)andinNovember2022(theArticleIVConsultation). ApprovedBy TobiasAdrian PreparedBy MonetaryandCapitalMarketsDepartment CONTENTS Glossary4EXECUTIVESUMMARY6BACKGROUND8 A.FinancialSectorLandscape8 B.MacrofinancialChallenges10 C.SystemicRisksandVulnerabilities11 D.Scenarios14 SOLVENCYSTRESSTEST16 A.Overview16 B.BalanceSheetProjections16 C.CreditRisk16 D.MarketRisk19 E.NetInterestIncome21 F.Non-InterestIncomeandOtherProjections22 G.Results23 H.SensitivityAnalysis26 LIQUIDITYSTRESSTEST28 A.Overview28 B.LiquidityCoverageAnalysis29 C.Cash-FlowAnalysis30 D.NetStableFundingAnalysis31 E.ResultsandRecommendations32 ACCESSTOFUNDINGANALYSIS32 A.Overview32 B.Model33 C.ResultsandRecommendations33 D.DomesticInterbankContagionandInterconnectednessAnalysis35 E.Cross-BorderContagionandInterconnectednessAnalysis36 References39 FIGURES 1.BankingSector10 2.HouseholdandCorporateIndebtedness12 3.CrossBorderExposuresandSourcesofFunding13 4.FundingSourcesforFinnishBanks13 5.MacroeconomicScenario15 6.AnnualNPLProjection17 7.AnnualCorporatePDProjections18 2INTERNATIONALMONETARYFUND 8.SovereignPD19 9.AnnualAssetRateProjections22 10.AnnualLiabilitiesRateProjections23 11.SolvencyStressTestResults25 12.RiskProjections26 13.SensitivityAnalysisResults27 14.FundingStructure28 15.LCRAnalysisResults30 16.CashflowAnalysisResults31 17.BondYieldsandSpreads34 18.DomesticInterbankContagionAnalysisResults36 19.ClaimsofFinnishBanks37 20.CrossBorderContagionAnalysisResults38 TABLES 1.FSAPSystemicRiskAnalysisKeyRecommendations7 2.FinancialSystemAssets:2016and20219 3.LCRStressedFactors29 APPENDIXES I.RiskAssessmentMatrix40 II.StressTestMatrix42 III.ProbabilitiesofDefault:EconometricEstimation48 IV.FinlandCorporateProbabilitiesofDefault:EconometricEstimation51 V.InterestRates:EconometricEstimation52 VI.LiquidityStressTestScenarioSpecification55 VII.BondYieldModelCalibration60 ACAmortizedCost Glossary ARIMAAutoregressiveIntegratedMovingAverage ASRFAsymptoticSingleRiskFactor BICBayesianInformationCriterion BNABankNetworkAnalysis BoFBankofFinland CDSCreditDefaultSwap CET1CommonEquityTier-1 DSTIDebt-Service-To-Income DTDownturn ECBEuropeanCentralBank ECMErrorCorrectionModel EDFExpectedDefaultFrequency EUREuros EURIBOREuroInterbankOfferedRate FIN-FSAFinnishFinancialSupervisoryAuthorityFINREPFinancialReporting FSAPFinancialSectorAssessmentProgram FVOCIFairValuethroughOtherComprehensiveIncomeFVPNLFairValuethroughProfitandLoss GDPGrossDomesticProduct GFCGlobalFinancialCrisis GFMGlobalMacrofinancialModel HQLAHigh-QualityLiquidAssets ICTInformationandCommunicationsTechnology IRBInternalRatings-Based LCRliquiditycoverageratio LGDLossGivenDefault LOTALiquidAssetsOverTotalAssets LSILessSignificantInstitution NBFINon-BankFinancialIntermediaries NIINetInterestIncome NIMNetInterestMargin Non-IINon-InterestIncome NPLNon-PerformingLoan NSFRNetStableFundingRatio OCIOtherComprehensiveIncome PBTProfitBeforeTax PDProbabilityofDefault PICPensionInsuranceCompany PITPoint-In-Time POEProvisionsOvertotalcreditExposures RAMRiskAssessmentMatrix 4INTERNATIONALMONETARYFUND ROAReturnOnAssets rOCIrestOtherComprehensiveIncome RWARiskWeightedAssets SFDRSustainableFinanceDisclosuresRegulation SISignificantInstitution SSMSingleSupervisoryMechanism STAStandardizedApproach TMTransitionMatrices TTCThrough-The-Cycle VECMVectorErrorCorrectionModel WEOWorldEconomicOutlook EXECUTIVESUMMARY Finlandisasmallopeneconomythatissignificantlyexposedtoglobalfinancialandeconomicconditions.FollowingtheGlobalFinancialCrisis(GFC),Finlandenteredalongrecessionledbythedeclineofitsinformationandcommunicationstechnology(ICT)sector.Withtheimplementationofsomestructuralreforms,Finland’scompetitivenessimproved,asdidgrowthandemployment,albeitatalowerrateofgrowth.TheeconomywaslesssignificantlyaffectedbytheCOVID-19pandemicrelativetoothereconomies,thankstoitslowexposuretoservice-intensiveeconomicsectors,fiscalpolicy,andotherinterventions.However,Finlandisnownavigatingaweakerec