The strong and rapid rise in interest rates has increased risks posed to Finland's financial stability, according to Marja Nykänen, deputy governor of the Bank of Finland.
Households that took on a lot of debt when interest rates were very low are at particular risk.
Nykänen said there is a possibility the Finnish economy may weaken even more than anticipated if households significantly cut back on their consumption this year.
"A loan taken out when interest rates were low can turn out to be excessively large, even where a household's financial standing ought to be sufficient for managing repayments. Households need to be able to pay other bills, too. If households cut back significantly on their spending, the Finnish economy could weaken more than expected," Nykänen said in a press release issued on Thursday.
Such a situation also puts the financial sector at risk, the central bank noted. As examples, it cited the recent failure of three US banks due to excessive risks as well as Switzerland's Credit Suisse, which had been struggling for a long time, and was bought by a competitor.
"The capital position of Finnish banks has remained strong, and they do not appear to have the same kind of balance sheet and liquidity risks as the banks that ended up in difficulty. Nevertheless, attention must also be paid in Finland to bank funding risks and the sufficiency of banks' liquidity," Nykänen said in the release.
The central bank noted that reforms of international regulations have improved banks' resilience, adding that Finnish banks are compelled to maintain higher capital requirements than before, " allowing system-wide risks to be covered."
"Finnish banks are also well equipped to meet the growing risks in the Nordic housing and real estate markets," the bank said.
It added that introducing a mandatory cap on debt service-to-income (DSTI), as recommended by a finance ministry working group, would have a positive impact on financial system stability.
"The requirement would impose an upper limit on how much of a borrower's income can be taken up by debt servicing costs," the bank said.
"The spring turbulence that we saw in the banking sector was a reminder of how quickly the situation can escalate if confidence in banks is shaken. Financial system stability is established through persistent work. A stronger cap on household borrowing in Finland and common protection for bank deposits across Europe would be key steps," Nykänen said.
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