Blog: In review: prudential regulation of banks in Finland – Lexology

All questions

Prudential regulation

i Relationship with the prudential regulator

The FIN-FSA is responsible for the supervision of Finland’s financial sector. The objectives of the FIN-FSA’s activities are to enable balanced operations of credit institutions and other supervised entities as well as to foster public confidence in financial market operations. The FIN-FSA is further responsible for, inter alia, promoting compliance with good practice in the financial markets and disseminating general knowledge about the markets. These objectives and the duties of the FIN-FSA have been included in the Act on the Financial Supervisory Authority,20 which sets forth a comprehensive list of the FIN-FSA’s duties and delineates its supervisory powers. While the FIN-FSA operates in connection with the Bank of Finland, it makes independent decisions in its supervisory work. In addition to that work, the FIN-FSA is the authority that grants authorisations needed by many financial market participants, such as credit institutions, investment firms, fund management companies and insurance companies.

When carrying out its supervisory duties, the FIN-FSA has considerable authority to obtain information from the entities under its supervision, regardless of any rules on confidentiality. Furthermore, the entities supervised by the FIN-FSA are required to regularly file various reports to the FIN-FSA, which uses the reported data to monitor the supervised entities’ economic standing and risks, and to analyse their profitability, capital adequacy, risks and business volumes.

The FIN-FSA may exercise various supervisory powers, such as imposing a temporary prohibition on a person holding a managerial position in a supervised entity or, in extreme circumstances, cancelling an authorisation granted to a supervised entity. Moreover, the FIN-FSA may impose administrative sanctions, including administrative fines, public warnings and penalty payments. By the entry into force of the ACI in 2014, the sanctioning powers of the FIN-FSA were extended notably. In particular, the maximum amounts of penalty payments were increased significantly, bringing the maximum amounts of the penalty payments the FIN-FSA may impose for failures to comply with certain requirements of the ACI in line with the maximum penalties provided for in CRD IV.

A significant change took place in the supervisory regime when the new single supervisory mechanism (SSM) commenced its operations in Europe in November 2014. The SSM is a system of financial supervision comprising the European Central Bank (ECB) and the competent national authorities of the participating EU Member States. The legal basis for the SSM is Council Regulation (EU) No. 1024/2013. Within the SSM, the ECB will directly supervise significant credit institutions, and will have an indirect role in the supervision of less significant credit institutions, which continue to be supervised by their national supervisors in close cooperation with the ECB. At the time of writing, three Finnish credit institutions and groups (Nordea Group, OP Financial Group and Municipal Finance Plc) as well as the Finnish branch of Danske Bank A/S have been classified as significant institutions, and they have been transferred to the direct supervision of the ECB.

Under the SSM, the FIN-FSA will not use its powers directly where the ECB has jurisdiction. Therefore, in respect of institutions subject to the ECB’s direct supervision, the powers of the FIN-FSA described herein should be read also to refer to the ECB under the SSM.

The Act on the Financial Supervisory Authority contains specific provisions for the supervision of foreign supervised entities and their branches in Finland, and on cooperation with foreign supervisory authorities.

ii Management of banks

The board of directors of a bank shall create a framework for the bank’s internal governance. To fulfil this and other tasks, the board may opt to create committees or other working groups that are charged with assisting the board in fulfilling its duties. The day-to-day operations of the bank are the responsibility of its senior management, consisting of, for example, the managing director and members of the management group. It should be noted that while there is no legal requirement to have a management group, it is recommended to create such a body to provide assistance to the bank’s managing director in the fulfilment of his or her duties.

In addition to the organisational requirements discussed above, a bank’s managers must fulfil certain obligations (as set forth in the ACI and in the FIN-FSA’s regulations and guidelines) to manage the bank professionally and in a way that complies with sound business principles. All banks must maintain an effective risk-management system that seeks to manage and reduce risks to the bank’s liquidity and capital adequacy. The FIN-FSA’s supervision of banks’ corporate governance procedures takes particular note of certain items including, inter alia:

  1. the planning and management of a bank’s activities;
  2. the establishment of an internal audit function;
  3. the organisation of a bank’s activities in general (identification of conflicts of interest, storage of information, effective customer complaint procedures, etc.); and
  4. whether the bank maintains sufficient personnel for its operations, has created and follows a strategic business plan, and ensures that its operations are governed according to sound professional and ethical standards.

Each credit institution is required to follow certain rules, pursuant to the ACI, which include a requirement to have a remuneration policy that is in line with the business strategy, objectives, values and long-term interests of the institution. Additionally, remuneration policies must be consistent with, and promote, sound and effective risk management, and must not encourage risk-taking that exceeds the level of tolerated risk of the institution. The rules of the ACI governing remuneration policies are in line with those of CRD IV.

iii Regulatory capital and liquidity

Authorisation for a credit institution will be granted if the preconditions set out in the ACI are met. These include, inter alia, that the share capital, cooperative capital or basic capital must be at least €5 million and fully paid at the time of granting a licence, and that the credit institution must meet the capital requirements set out in the ACI.

The implementation of the CRD IV package introduced significant changes to the prudential regulatory regime applicable to Finnish credit institutions, including increased capital requirements, and changes in the elements of own funds and in the calculation of own fund requirements. The directly applicable CRR entered into force in Finland on 1 January 2014, whereas the requirements of CRD IV were implemented in Finland through the ACI.

In light of the implementation of the CRD IV package, Finnish regulatory capital and liquidity requirements are determined in accordance with both the CRR and the ACI. Pursuant to the ACI, a Finnish credit institution must continuously hold the required minimum amount of own funds and consolidated own funds, calculated in accordance with both the CRR21 and Chapter 10 of the ACI. Under the ACI, the definition of own funds corresponds to the definition of own funds as set forth in the CRR.22

Pursuant to the CRR, credit institutions must have a Common Equity Tier 1 capital ratio of at least 4.5 per cent, a Tier 1 capital ratio of 6 per cent and a total capital ratio of 8 per cent (each ratio expressed as a percentage of the total risk exposure amount). Furthermore, pursuant to the ACI, an additional capital conservation buffer of 2.5 per cent has been applicable to all credit institutions since 1 January 2015. The FIN-FSA is also authorised to set a countercyclical buffer of zero to 2.5 per cent based on macroprudential analysis. Both the additional capital conservation buffer and the countercyclical buffer must be satisfied with Common Equity Tier 1 capital. At the time of writing, the FIN-FSA has not imposed the countercyclical buffer. Since 1 January 2018, the FIN-FSA has been authorised to set a systemic risk buffer of between 1 and 5 per cent on credit institutions, applicable from 1 January 2019 at the earliest. The most recent decision of the FIN-FSA regarding the level of systemic risk buffer requirements for Finnish credit institutions was issued on 6 April 2020. Finally, there is an additional capital buffer requirement for other systemically important institutions (O-SIIs) whose failure or other malfunction would be expected to jeopardise the stability of the national financial system. The O-SII buffer for credit institutions operating in Finland may be set at zero to 2 per cent of the total risk exposure amount and must be satisfied with Common Equity Tier 1 capital. At the time of writing, the FIN-FSA has imposed additional capital requirements (O-SII buffers) on three Finnish credit institutions.23

The ACI also contains specific provisions on the consolidated supervision of banking groups, including provisions on the calculation of own funds on a consolidated basis, consistent with the CRR and CRD IV.

The FIN-FSA has issued further national regulations and guidelines on the calculation of capital requirements and large exposures. These instructions are related to the national application of the CRR and contain, inter alia, the FIN-FSA’s guidelines on the categorisation of various Finnish capital instruments into Common Equity Tier 1, Additional Tier 1 or Tier 2 instruments for the purposes of satisfying the own funds requirements imposed by the CRR and the ACI.

As regards liquidity requirements, Finnish credit institutions must comply with the liquidity requirements set forth in the CRR and as further specified by the Commission Delegated Regulation.24

iv Recovery and resolution

Directive 2014/59/EU, providing for the establishment of a European-wide framework for the recovery and resolution of credit institutions and investment firms (BRRD), entered into force on 2 July 2014. EU Member States were required to adopt and publish the implementing regulations to comply with the BRRD by 31 December 2014. In addition, the European Union has adopted a directly applicable regulation governing the resolution of the most significant financial institutions in the eurozone (i.e., a regulation establishing a Single Resolution Mechanism Regulation (the SRM Regulation)).25

In Finland, the BRRD was implemented mainly through two new acts: the Act on Resolution of Credit Institutions and Investment Firms (the Resolution Act)26 and the Act on the Financial Stability Authority.27 The latter regulates the Finnish Financial Stability Authority (the Stability Authority), which is the national resolution authority and is responsible for the resolution of credit institutions and investment firms in Finland. Among its key tasks, the Stability Authority draws up resolution plans for institutions, decides whether a failing institution is to be placed under resolution and applies the necessary resolution tools to an institution under resolution. The implementation of the BRRD also involved amendments to dozens of existing acts, most notably to the ACI, and the repeal of the Act on the Temporary Bank Levy and of the Act on the Government Guarantee Fund.

Under the recovery and resolution regime, credit institutions are generally required to draw up recovery plans to secure the continuation of their business in the event of financial distress. These plans must include options for measures to restore the financial viability of the institution and must be updated annually. The plans must be submitted to the scrutiny of the FIN-FSA.

In the context of the new legislation, the FIN-FSA has been empowered to apply early intervention tools to banks and investment firms. These tools may be used if the FIN-FSA has solid reasons to believe that an institution will fail in regard to its licensing conditions, liabilities or obligations under the capital adequacy regulations within the next 12 months. The early intervention tools include, inter alia, the right of the FIN-FSA to:

  1. require the bank’s management to implement measures included in the recovery plan;
  2. convene a general meeting of shareholders for the purpose of taking necessary decisions for recovery;
  3. require the removal of members of the bank’s management; and
  4. require changes to the legal and financial structure of the institution.

Pursuant to the Resolution Act, the Stability Authority shall set up and maintain a resolution plan for each institution. The resolution plan must be ready for execution in the event that the institution needs to be placed in a resolution process.

The Resolution Act vests the Stability Authority with resolution powers and tools as provided in the BRRD. If the Stability Authority considers that an institution is failing or likely to fail, and that there is no reasonable prospect that any private or early intervention measures or write-down of capital instruments would prevent the failure, and further that resolution is necessary in the public interest, the Stability Authority is empowered to declare and initiate a resolution process in respect of the institution.

During such a process, the institution could be subject to the exercise of a number of resolution tools: mandatory write-down of debts or conversion of debts into equity (bail-in), sale of business, bridge institution and asset separation. To continue the operations of the institution, the Stability Authority has the power to decide upon covering the losses of the institution by reducing the value of the institution’s share capital or cancelling its shares.

The BRRD (and consequently, the Resolution Act) provides a requirement for credit institutions to meet the minimum requirement for own funds and eligible liabilities (MREL) designed to ensure sufficient loss-absorbing capacity to enable the continuity of critical functions without recourse to public funds. All institutions must meet an individual MREL requirement calculated as a percentage of total liabilities and own funds and set by the relevant resolution authorities. The Stability Authority has started gathering information from credit institutions in its direct jurisdiction. Based on the gathered information, the Stability Authority has been preparing individual resolution plans and decisions on eligible liabilities under MREL for Finnish credit institutions. The process and schedule of the planning and decision process varies between institutions.

The SRM Regulation has established a pan-European resolution authority, the Single Resolution Board (SRB). The SRB has been fully operational, with a complete set of resolution powers, since January 2016. These powers have replaced the resolution powers of the Stability Authority in respect of the Finnish institutions that are subject to the SRM Regulation.28

As part of the single resolution mechanism, a new Single Resolution Fund (SRF) managed by the SRB commenced operations in January 2016. Finnish credit institutions must pay annual contributions to the SRF. The amount of the contributions shall be determined in accordance with the SRM Regulation.

The Finnish parliament adopted extensive changes to the ACI and the Resolution Act by implementing the changes relating to the EU’s second banking package. The main amendments further specify the grounds for setting various capital requirements; lay down provisions concerning the setting of an equity ratio basis of certain capital requirements or asset distribution restrictions; impose a licensing requirement on financial sector holding companies and extend certain aspects of the regulation and monitoring of credit institution activities to cover these holding companies; lay down provisions on a new calculation model for assessing the interest risks of financial accounts; lighten the regulation of credit institutions’ remuneration; and partially expand the circle of people covered by the regulation of related party lending. As for resolution, the main amendments supplement the regulation concerning the minimum requirement for own funds and eligible liabilities and lay down provisions on new powers for the resolution authority to restrict the distribution of assets by institutions and suspend the implementation of agreements. Furthermore, in relation to amalgamations of deposit banks, the Stability Authority was given powers to use the resolution tools towards the whole amalgamation including its central institution and member banks if the amalgamation as a whole fulfils the criteria for resolution.

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