Significant real estate risks in the Finnish financial sector – mitigated by strong buffers

The property market boom came to an end in mid-2022 due to the higher interest rate level as well as the weak economic situation and confidence sentiment. While real estate transaction volumes and the prices of old apartments declined, construction froze up. Only very recently, with the declining interest rates, there have been small signs of a pick-up in the economy and the real estate markets. However, there are still considerable downside risks associated with the development of the real estate markets. If the Finnish economy were to perform weaker than anticipated, for example on account of a realisation of geopolitical risks, it could increase bankruptcies, unemployment and lay-offs. The situation of the real estate sector and construction in particular would be challenging in this type of a scenario of weaker-than-expected performance.

– The Finnish financial sector has significant credit, investment and liquidity risks related to the real estate sector, which could arise if the operating environment were to deteriorate more severely than expected. In the current weak cyclical situation, the sector has been protected from these risks by solid capital adequacy and risk management, among other things. The monitoring and assessment of supervised entities’ real estate risks have been one of the focus areas of the FIN-FSA's supervision in 2024, and therefore we have conducted thematic reviews and taken supervisory actions related to the topic in the banking, insurance and fund sectors, states Tero Kurenmaa, Director General of the FIN-FSA.

In June 2024, housing loans and other loans secured by real estate granted by Finnish banks accounted for 59% of all household and corporate loans. Realised credit losses and the share of non-performing loans pertaining to these loans have remained at a low level, but the proportion of loans classified as having significantly increased credit risk has grown, particularly in the construction sector. Banks are also exposed to real estate risks through the real estate collateral on their loans. The values of real estate collateral have been cut in recent years more than before. According to the FIN-FSA's thematic review published in the autumn, banks have shortcomings in their valuation practices for real estate collateral.

The real estate risks of the banking sector are mitigated and banks are protected by several factors. Banks’ capital adequacy has remained strong, in addition to which, the repayment capacity of mortgage borrowers is assessed separately through various stress calculations before granting credit. Banks also apply a valuation haircut to any collateral received by them, which hedges them against a decline in the market value of residential and real estate collateral given. Banks’ risk-bearing capacity has also been proven strong in various stress tests conducted by authorities, where the scenarios have also included an assumption of a steep decline in real estate values.

Finnish insurance companies and employee pension institutions are significant investors on the Finnish real estate markets. They invest in real estate both directly and indirectly via funds. Insurers’ real estate holdings accounted for approximately 10% of their total investments in June 2024. The return on real estate investments has lately been negative.

Real estate investments do not have a particularly significant weight in pension insurers’ allocations, and their use of leverage is also very conservative. Therefore, the negative return on real estate has not had a significant impact on overall portfolio return. Employee pension institutions’ resilience to even significant losses from real estate investments is strong. Employee pension institutions’ long investment horizon also has a stabilising impact on the real estate markets. Meanwhile, the variation in life and non-life insurance companies’ real estate investment returns has been cushioned by, for instance, rental yield. Thanks to their solid capital adequacy, high allocation to lower-risk assets and long investment horizon, life and non-life insurance companies on average are resilient to real estate investment risks.

Real estate funds have been a significant investor group on the domestic real estate market, but they only account for about 7% of the combined net asset value of funds registered in Finland. The challenging real estate market has reflected on open-ended real estate funds in particular through an increase in redemption orders. As a result, open-ended real estate funds have amended redemption frequency (to be open more seldom) starting from 2023. Several management companies have been forced to either restrict or suspend redemptions from open-ended real estate funds due to the challenging real estate market environment. As a result of these actions, funds have avoided forced asset sales on a large scale, which has also helped stabilise the real estate market.

For further information, please contact

Samu Kurri, Head of Department, Digitalisation and Analysis Requests for interviews are coordinated by FIN-FSA Communications, tel. +358 50 385 5030 (weekdays 9.00–16.00).

Appendices

• Article (in Finnish): Significant real estate exposures in the Finnish financial sector – mitigated by strong buffers