New tools needed to contain household indebtedness
Household indebtedness has been rising for 20 years and currently stands at an all-time high: at the end of the review year, almost 400,000 Finns had a payment default on record. Over-indebted people or households are prone to protracted financial and social problems.
From the perspective of the economy, households’ over-indebtedness also weakens the capacity of the economy to adjust to adverse surprises. Highly indebted households may, for example, reduce their consumption when facing financial problems, such as unemployment, during a downturn. This in turn has negative impacts on the whole economy and companies’ activities. As consumption weakens and households’ debt burden grows further, banks’ credit losses may grow indirectly and with a lag. Credit losses, in turn, weaken banks’ capital adequacy and lending capacity.
The bulk of the household loan stock consists of housing loans. For the time being, the debt-servicing burden of households with housing loans has not increased significantly, as the general level of interest rates and interest rates on housing loans have remained very low for a long time now. Average loan periods have also lengthened. Household debt has been augmented not only by housing loans but also by consumer credit and indirect forms of indebtedness, such as housing company loans.
Macroprudential policy maintains financial stability
The objective of effective macroprudential policy is to maintain the stability of the financial system as a whole. It supports both conventional banking supervision as well as fiscal and monetary policies to achieve sustainable economic growth. The safeguarding of stability is contingent on three things:
- financial institutions’ adequate risk buffers
- the possibility to tighten the requirements in an upswing to prevent the growth of risks and vulnerabilities, and
- the possibility to ease the requirements in times of crisis to alleviate the situation.
In addition to banks’ capital buffers, macroprudential policy includes so-called borrower-based measures. Almost all European countries have adopted several borrower-based measures into their regulations. In Finland, only a maximum loan-to-value ratio, so-called loan cap, is in place. Both the European Systemic Risk Board (ESBR) and most recently the International Monetary Fund (IMF) have recommended that tools to contain lending should also be adopted in Finland. The IMF's recent statement on Finland notes that the growing household indebtedness increases the need to enhance the macroprudential toolkit by new borrower-based instruments.
The FIN-FSA Board has voiced its concern on several occasions about households’ over-indebtedness in connection with the publication of its macroprudential decisions. Through its recommendation issued in December 2021, to be specified further in the first half of 2022, the Board's aim is to contain, even more strongly than previously, the excessive growth of household indebtedness. In granting credit, it is also important to consider potential changes in total debt-servicing costs. The loan applicant's debt-servicing capacity should not be compromised by an increase in interest rates or a disruption in the repayment of debt by the loan applicant1.
Need for borrower-based measures
Towards the end of 2019, the working group on excessive household indebtedness, established by the Ministry of Finance, completed its proposal. Based on the proposal, a Government bill is being prepared and will be submitted for consideration by the Government in late spring 2022. The draft Government bill on measures to curb indebtedness does not include the so-called debt-to-income (DTI) ratio or other income-linked instruments to restrict lending. The DTI would limit a borrower's loan-to-income ratio to a predetermined maximum amount.
Other potential instruments to limit indebtedness could include a cap on the loan amount relative to income (LTI, Loan to Income), debt servicing costs to income (DSTI, Debt Service to Income) or loan servicing costs to income