An analysis by the Financial Supervisory Authority (FIN-FSA) has found differences and potential shortcomings in the way Finnish banks classify loans according to stages of impairment. The current environment of elevated risks highlights the importance of appropriate classifications and adequate and timely recognition of impairments. Excessively low and delayed loan loss provisioning may, if the risks materialise, lead to higher impairments and a weakening of banks' capital adequacy.

The sharp rise in interest rates and living costs to significantly higher levels than in previous years and the weakening of the economy has, in the past couple of years, increased Finnish banks' credit risks and tested the effectiveness of their credit risk management systems. The FIN-FSA has paid particular attention to the credit risk management of the banks, as credit risks have been one of the priorities in the prudential supervision of banks in 2024. Over the course of 2024, the FIN-FSA has analysed the appropriateness of Finnish banks' impairment staging of loans in relation to certain requirements of the international financial reporting standard IFRS 9, and also analysed the coverage of loan loss provisions and the predictive power of impairment models. This thematic analysis, which has now been completed, is in part a continuation of the analysis completed in 20231.

“Impairment staging of loans should reflect the customer's credit risks and any changes in them. If banks fail to detect early enough significant increases in credit risks, their loan loss provisions may be too low. In such cases, if the risks materialise and turn out to be greater than expected, this may weaken banks’ capital adequacy and their ability to finance investments necessary for the economy, especially in crisis situations where it is important that financial intermediation is trouble-free,” says Tero Kurenmaa, Director General of the Financial Supervisory Authority.

Differences in impairment staging undermine the comparability of banks and the predictability of changes in credit risks

The FIN-FSA's analysis revealed differences in banks' impairment staging of loans2 compared with the requirements of IFRS 9. Some of these differences and detected shortcomings were justifiable. The analysis completed in 2023 found discrepancies between banks in their impairment staging of common corporate borrowers. Such discrepancies continued and were relatively common. The discrepancies in impairment staging are partly explained by differences in the payment behaviour of corporate borrowers. The same borrower might repay its loans to each bank in a different manner.

The relationship between a bank's financial position and its total impairments varied between banks. In particular, a slight positive correlation was found between bank profitability and total impairments. However, the analysis showed no clear signs that banks with the lowest capital adequacy or profitability would regularly have the lowest levels of loan loss provisions.

The thematic analysis also examined transfers of loans between stages of impairment and delays in these transfers. Transfers to stage 3 directly from stage 1 and also rapid transfers from stage 2 to 3 made it difficult to predict future changes in credit risk. An increase in direct transfers of loans between stages 1 and 3 will lead to higher impairments and a negative effect on bank profits if a significant increase in credit risk has not been recognised before a loan has become credit-impaired.

For further information, please contact:

Samu Kurri, Head of Department, Digitalisation and Analysis. Requests for interviews are coordinated by FIN-FSA Communications, tel. +358 9 183 5030, Mon–Fri 9:00–16:00.

Appendix

Article: ‘Differences in appropriateness and predictive capacity of impairment staging by Finnish banks' (in Finnish).

1 Article: ‘Early signs of growth in Finnish banks’ credit risks – differences in Finnish banks' impairment staging of common borrowers’ (in Finnish).

2 Stage 1 loans are loans where the credit risk has not grown since initial recognition. Stage 2 loans are loans where the credit risk has increased significantly since initial recognition. Stage 3 loans are considered credit-impaired.