EBA published an opinion following the notification by FIN-FSA of its intention to extend a measure introduced in 2017 about the use of Article 458 of the Capital Requirements Regulation (CRR). The measure consists of the extension of a credit-institution-specific minimum level of 15% for the average risk-weight on residential mortgage loans applicable to credit institutions that adopted the internal ratings-based (IRB) approach. Based on the evidence submitted, EBA does not object to the extension of the proposed measure, which will be applied from January 01 to December 31, 2020.
The recent EBA opinion is addressed to the European Council, EC, and the Finnish authorities. In this opinion, EBA, in line with the warning on the vulnerabilities of the residential real estate sector issued by ESRB, acknowledged that the systemic risks and vulnerabilities related to housing loans and household indebtedness in Finland could pose a threat to the financial stability of banks; therefore, EBA did not object to the deployment of macro-prudential measures. In an earlier opinion issued on July 27, 2017, EBA had not objected to the adoption of the above measure, keeping in mind the expected impact of this measure on increasing resilience of the banking sector in Finland. However, the concerns about the choice of measure, the calibration of measure, and the impact of measure, which EBA had raised (to EC) in its July 2017 opinion, remain valid.
However, EBA believes that the intensity of macro-prudential or systemic risk in the financial system, with the potential to have serious negative consequences for the financial system and the real economy, in Finland remains elevated. Most factors affecting changes in the intensity of macro-prudential or systemic risk underlying the measure remain unchanged from those observed in the original measure, such as a persistent structurally high level of debt-to-income ratio, the majority of residential mortgage loans being tied to variable interest rates, and an increase in house prices over the long term. A systemic risk buffer was also imposed on all credit institutions in Finland in 2018. EBA acknowledged the limitations listed by FIN-FSA on the use of this buffer to address the identified macro-prudential concern, but noted that the proposal to include a risk-weight floor in Finland came a few years before the entry into force of the new amendments to the Capital Requirements Directive and Regulation (CRD5/CRR2). For this reason and keeping in mind the future implementation of output floors envisaged under Basel III, EBA would encourage FIN-FSA to closely monitor developments in the property market and reassess the rationale for this measure in light of the outcome changes in the regulation and possible overlap with the output floor.
Explaining the rationale for the decision to apply this measure, FIN-FSA has stated that the re-domiciliation of Nordea in 2018 to Finland further increased the size, degree of concentration, and interconnectedness of the Finnish banking sector, compared with the rest of the Nordic banking system. FIN-FSA also stated that, according to international comparisons, the average risk-weights of Finnish banks are still among the lowest in EU. Therefore, if the risk-weight floor set by the original national measure were repealed, FIN-FSA believes that there would still be a clear negative impact on the risk-weights of banks. FIN-FSA mentioned that the measure applies an average risk-weight floor rather than an add-on because an average is seen as less intrusive in terms of effects on credit pricing and risk-based allocation of credit to the real economy. Another reason for application of the average risk-weight floor was that the risk profiles of the housing loan stocks of individual credit institutions were rather similar and the floor provided a more uniform back-stop when allocating capital to cover for the inherent risks in mortgages. The FIN-FSA Board will reassess the need for an average minimum risk-weight for housing loans once CRD5/CRR2 amendments enter into force in 2021.
Keywords: Europe, EU, Finland, Banking, Systemic Risk Buffer, CRD 5, CRR 2, Internal Approaches, Macro-prudential Policy, Systemic Risk, FIN-FSA, EC, EBA
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