Stress test results testify to the health of Finnish banks ‒ but the methodology used by supervisors fails to account for Nordic specificities

Finnish banks are financially stable. This was proven by the results of the EU-wide stress test published by the European Banking Authority (EBA) on 28 July 2023. The Finnish banking sector is in a robust condition, with a low ratio of non-performing loans.

“The results show there is no need to tighten banks’ capital requirements. This is a good thing because doing so would directly weaken Finnish banks’ capacity to finance households, businesses and green investments”, says Finance Finland’s CEO Arno Ahosniemi.

Capital requirements are a set of rules that obligate banks to maintain a certain level of own funds so they can withstand sudden negative shocks to the operating environment without causing spillover problems in the rest of the economy.

Peculiar assumptions in the test scenarios impaired Nordic banks’ results

Finance Finland criticises the methodological choices made by the supervisors. The main point of stress testing is to calculate several scenarios for economic development and then subject banks to these scenarios to see how their capital position would withstand the conditions. Methodological choices such as the ratios and thresholds used in the test therefore make a big difference in terms of the final results.

“The current methodology may make resilient Nordic banks look weaker than they really are and give reason to raise their capital requirements too high compared to their actual risk level. This would directly affect the lending capacity of banks”, Ahosniemi points out.

The EBA stress test model does not sufficiently acknowledge the higher interest rate environment’s effect on the Nordic sector. One of the set constraints is that, under the adverse scenario, nominal net interest income cannot exceed its 2022 level. But due to the popularity of variable interest rate loans in the Nordics, rising interest rates do not only raise the interest expenses but also the interest income of Nordic banks. In Central and Southern Europe, fixed interest rate loans are much more typical, and interest income is usually more stable than interest expenses.

The test also assumes that a bank pays dividends to its shareholders and bonuses to its management regardless of the bank’s financial position. This goes against the operating guidelines and policies of many banks.

“Banks submitted their comments on the test methodology to the supervisors in good time last year. It is discouraging that they were not taken into account”, says Ahosniemi.

The stress test results are used by the European Central Bank and the national competent authorities, including the Finnish Financial Supervisory Authority, when they assess the capital requirements of the banks under their supervision. Because the test has such a tangible impact on the sector, its methodological choices must be more carefully evaluated in the future.