BANK OF FINLAND ANNUAL REPORT 2016

Transcription

1 BANK OF FINLAND ANNUAL REPORT 2016 The euro area economy grew, but inflationary pressures remained slight. Monetary policy continued to be accommodative. Finland left recession behind. Exports, employment and public finances nevertheless remained weak. Household debt levels allied to the banking sector s Nordic connections and concentration increased financial system vulnerability. Digitalisation is reflected in changing payment practices. Cash use is on the decline.

2 Bank of Finland Annual Report 2016

3 Front cover photo by Mari Hienonen

4 Bank of Finland Established 1811 Street address Snellmaninaukio, Helsinki Postal address PO Box 160, FI Helsinki Finland Telephone national international Fax SWIFT SPFB FI HH info@bof.fi firstname.lastname@bof.fi Internet Bank of Finland museum The art site Regional offices Vantaa Turvalaaksontie 1, Vantaa, PO Box 160, FI Helsinki, Telephone Oulu Kajaaninkatu 8, BO Box 103, FI Oulu, Telephone Drafted in accordance with Section 19 of the Act on the Bank of Finland. The figures in the Annual Report are based on data available in February ISSN (print) ISSN X (online) Grano Oy Helsinki 2017 Bank of Finland Annual Report

5 Contents Governor's editorial...6 Bank of Finland promoter of stability...7 Bank of Finland activities Monetary Policy...8 The ECB's monetary policy and its preparation...8 Implementation of monetary policy in the euro area and Finland The Bank of Finland and economic policy in Finland...17 Financial system...20 Financial stability...20 Financial system policy...22 Financial market infrastructure...26 Financial asset management...29 Bank of Finland s financial assets and financial asset management Investment risks and risk management...31 Banknotes and coins...33 Other operations...36 Research...36 Bank of Finland Institute for Economies in Transition...36 Statistics...38 International activities...40 Communications...42 Management and personnel...44 Strategy...44 Management system...48 Objectives and results framework...48 Action planning...48 Personnel and budget frameworks...48 Risk management...49 Personnel...49 Budget and operating expenses...51 Budget for the Bank of Finland...51 Pension fund budget...51 Budget for the Financial Supervisory Authority...52 Environment...53 Total risk exposure...55 Financial assets...55 Monetary policy operations...55 Total risk exposure on the balance sheet Bank of Finland Annual Report 2016 Contents

6 Financial statements...59 Balance sheet...60 Profit and loss account...62 The Board s proposal on the distribution of profit...63 Accounting conventions...64 Notes on the balance sheet...68 Notes on the profit and loss account...80 Appendices to the financial statements...85 Notes on risk management...89 Auditor s report...93 Statement regarding the audit as defined in Article 27 of the Statute of the European System of Central Banks and the European Central Bank...94 Appendices...96 Monetary policy measures of the Eurosystem in Key measures affecting the financial markets in Main opinions issued by the Bank of Finland in Bank of Finland publications in Supplementary tables Organisation of the Bank of Finland Boxes Box 1. ECB purchase programme extended to include corporate bonds...12 Box 2. The European Systemic Risk Board issued a warning on vulnerabilities in the residential real estate sector...23 Box 3. The Bank of Finland s role in the macroprudential system Box 4. Payment methods facing major overhaul...28 Box 5. Financial cycle explains long-term effects of monetary policy...37 Box 6. Granular credit database supports decision-making...39 Box 7. Bank of Finland representatives at the ECB, EU and other international bodies in Box 8. Bank of Finland's mission, vision, strategy and values...45 Box 9. Bank of Finland objectives and results framework Contents Bank of Finland Annual Report

7 Governor's editorial The eventful year of 2016 brought positive economic signals. Over the course of the year, euro area growth was on a firmer foundation. The accommodative stance of monetary policy played a considerable part in this, as the ECB s monetary policy fed through significantly into the economy. Euro area inflation remained in line with the forecasts, if still slower than the ECB s price stability objective. Therefore, monetary policy will remain accommodative for a prolonged period. The international operating environment saw a number of changes that the markets considered would bring significant negative shocks to the economy. The Brexit referendum in the United Kingdom, the US presidential election and the rejection of constitutional reform in the Italian referendum nevertheless produced only short-term ripples on the markets. The long-term effects will, however, become clear only with time. Negotiations over the UK exit from the EU have not yet begun. At the time of writing we have only seen preliminary indications of the economic policy approach of the new US administration and are still awaiting a detailed programme. During the course of the year, Finland s economy, too, began a gradual return to growth. In the Bank of Finland forecast published in December, it was possible to announce the end of recession. The economy was bolstered particularly by domestic demand, especially the strengthening of construction activity and private consumption. Industrial output also began to take a turn for the better. The broad labour market agreement strengthened costcompetitiveness. Despite the recovery, the outlook for future growth is more moderate than we are accustomed to, on account of the decline in the working-age population and weak productivity development. Banks operating in Finland are financially sound, and this has supported the transmission of monetary policy into the domestic economy. The Bank of Finland has drawn attention to the growth in household indebtedness and the structural vulnerabilities relating to the housing loan market. The same issues were also highlighted by the European Systemic Risk Committee when it warned Finland of medium-term vulnerabilities relating to household debt. The Bank of Finland has shown initiative within the Eurosystem and invested further effort in monetary policy analysis and the development of tools for this purpose. The Bank carried out its share of the ECB s expanded asset purchase programme, which has expanded its balance sheet. The risks to the Bank s capital adequacy were anticipated, and particular attention was therefore devoted to monitoring and reporting. Globalisation and digitalisation affect the operating environment of the Bank of Finland and society as a whole in a number of ways. Bank of Finland experts have therefore participated in the debate insofar as it touches on economic growth. Digitalisation is also changing the activities of the financial markets to a significant degree. The Bank reinforced its work in this area by establishing at the beginning of 2017 a special cross-departmental digitalisation process. Overall, 2016 saw a number of surprises in both politics and the economy that contain downside risks to the economy. Despite this, euro area growth has strengthened further. The outlook for Finland, too, is gradually improving, although there is no shortage of challenges, particularly in regard to the public finances and long-term unemployment. Erkki Liikanen Governor 24 February Bank of Finland Annual Report 2016 Governor's editorial

8 Bank of Finland promoter of stability The Bank of Finland is the monetary authority and national central bank of Finland. It is also a member of the Eurosystem, which is responsible for the monetary policy and other central bank tasks of euro area Member States. The Bank of Finland supports and fosters economic stability. Price stability, secure payment systems and a reliable financial system promote sustainable economic growth, employment and the wellbeing of Finnish society. The Bank of Finland is responsible for the issuance of cash in Finland and for its quality and availability. The Bank has two regional offices for the management of currency supply, one in Oulu and one in Vantaa. The Bank of Finland is responsible for safeguarding the stability of the Finnish financial markets in cooperation with the Financial Supervisory Authority (FIN-FSA) and the Ministry of Finance. The FIN-FSA, which is Finland s national authority for financial and insurance supervision, operates in connection with the Bank of Finland but is independent in its decision-making. It is part of the European Single Supervisory Mechanism, which supervises euro area banks under the direction of the European Central Bank. The Bank of Finland s status is defined in the Finnish constitution. The Bank is an independent institution governed by public law that operates under the guarantee and care of Parliament. Supervision of the Bank s activities is undertaken by the nine-member Parliamentary Supervisory Council, appointed by Parliament. The Bank of Finland is a member of the Eurosystem, which comprises the European Central Bank (ECB) and the national central banks of the EU Member States that have adopted the euro as their single currency. Euro area monetary policy is decided by the Governing Council of the ECB, of which the Governor of the Bank of Finland is a member. Experts from the Bank of Finland support the Governor s activity on the Governing Council and participate in preparation of the single monetary policy in the various committees of the European System of Central Banks. In 2016, the Board of the Bank of Finland comprised Governor Erkki Liikanen, Deputy Governor Pentti Hakkarainen and Member of the Board Seppo Honkapohja. The FIN-FSA has a Board of its own, which was chaired by Pentti Hakkarainen, Deputy Governor of the Bank of Finland. At the end of 2016, a total of 376 staff were employed in the Bank of Finland s head office in Helsinki and the regional offices in Oulu and Vantaa. The Bank of Finland and the FIN-FSA together employed 558 persons in total. The FIN-FSA produces its own annual report. Photo: Peter Mickelsson. Bank of Finland Deputy Governor Pentti Hakkarainen (left), Governor Erkki Liikanen and Member of the Board Seppo Honkapohja. Bank of Finland promoter of stability Bank of Finland Annual Report

9 Bank of Finland activities 2016 Monetary Policy The ECB's monetary policy and its preparation The main objective of the Eurosystem s monetary policy is to maintain price stability in the euro area. The Governing Council of the ECB has defined this objective as meaning, in practice, that the year-on-year increase in consumer prices should be below, but close to, 2% over the medium term. Monetary policy can also support other economic policy objectives of the EU as long as the objective of price stability is not jeopardised. The members of the Executive Board of the ECB and the governors of the national central banks, including the Governor of the Bank of Finland, as members of the Governing Council of the ECB, participate in monetary policy decision-making. Experts from the Bank of Finland contributed to economic analysis and the preparation of monetary policy decisions by, among other things, taking an active part in the Eurosystem s Monetary Policy and Market Operations Committees. In March 2016, the ECB provided further monetary policy accommodation. At that time, it lowered its policy rates and decided to launch a new series of targeted longer-term refinancing operations (TLTRO II) (Chart 1). In addition, the ECB included bonds issued by non-bank corporations in its expanded asset purchase programme (EAPP) and decided to increase the amount of the monthly asset purchases to EUR 80 billion. The transmission of monetary policy into bank lending remained effective throughout the year, and the euro area continued to witness fairly brisk economic growth. Moreover, long-term inflation expectations began to strengthen in early September. In December, the Governing Council assessed euro area growth would proceed as before and inflationary pressures would remain subdued. It therefore decided to continue the asset purchase programme until the end of 2017, but brought the monthly purchases back to the level of EUR 60 billion, starting in April Further monetary policy accommodation provided in March At the beginning of 2016, euro area financing conditions were improving, partly driven by the ECB s monetary policy. Government bond yields and average interest rates on new corporate and household loans were on a downward trend. In particular, annual growth in the corporate loan stock was accelerating, and credit standards on corporate and housing loans had eased. Targeted longer-term refinancing operations had exerted an easing impact on credit terms and conditions. Despite favourable developments in financing conditions, financial market risk indicators rose, and long-term inflation expectations were still fading. At its monetary policy meeting of 21 January, the Governing Council considered that uncertainty about growth prospects in the emerging economies, volatility on the financial and commodity markets and geopolitical factors reinforced downside risks, and therefore euro area inflation had remained lower than forecast. The Governing Council therefore announced its intention to review and possibly reconsider the monetary policy stance at its meeting in early March. According to the March 2016 ECB staff macroeconomic projections, the outlook for euro area growth had weakened since December 2015, due to more muted growth than forecast in the global economy and particularly in the emerging economies, the stronger exchange rate of the euro and the presence of higher financial market uncertainty. The inflation forecast for 2016, in particular, was significantly downgraded because of the fall in the price of crude oil. 8 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

10 At its monetary policy meeting of 10 March, the Governing Council decided to decrease the interest rate on the main refinancing operations and the interest rate on the marginal lending facility by 0.05 of a percentage point and the interest rate on the deposit facility by 0.10 of a percentage point. Accordingly, since 16 March, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility have been 0.00%, 0.25% and 0.40% respectively. In connection with the decision, the Governing Council indicated that it expected the key ECB interest rates to remain at present or lower levels for an extended period, and well past the horizon of the net asset purchases. Another important decision at the meeting was to increase the monthly purchases under the EAPP to EUR 80 billion from the previous EUR 60 billion, starting in April. It was decided to continue these purchases at least until the end of March 2017, or beyond, if necessary, until there is a sustained adjustment in the path of inflation consistent with the inflation target. A third key decision made at the meeting was to extend the coverage of the purchase programme by accepting for inclusion within it investment-grade eurodenominated bonds issued by non-financial corporations established in the euro area. It was also decided to launch a second series of targeted longer-term refinancing operations (four in all) in June. The longest maturity of an individual operation can be four years. The interest rate will be fixed for each operation at the rate on the main refinancing operations prevailing at the time of take-up. However, if a benchmark linked to net lending is exceeded, the interest rate can be as low as the interest rate on the deposit facility prevailing at the time of the allotment of each operation. Counterparties were offered an opportunity to roll over amounts borrowed under the previous TLTROs into TLTRO II operations, which have more attractive terms and conditions and include no mandatory early repayments. Following the March monetary policy meeting, financial market risk indicators declined. The strengthening trend of the euro ended in the early part of May. According to the Bank Lending Survey (BLS), the EAPP and the negative interest rate on the deposit facility were deemed as Chart 1. Eurosystem policy rates % Eurosystem interest rate on the main refinancing operations 2. Eurosystem interest rate on the marginal lending facility 3. Eurosystem interest rate on the deposit facility Sources: European Central Bank and Macrobond. having an easing impact on credit terms and conditions. The monetary policy meeting of 21 April concluded that the March decisions had improved financing conditions in the euro area and that the pass-through of monetary policy to firms and households had strengthened. Global growth and geopolitical factors were, however, seen as being surrounded by a high degree of uncertainty, and the risks to euro area economic activity were judged to still be tilted on the downside. The Bank of Finland forecast for the international economy, published on 21 March, predicted that euro area growth over the forecast horizon would rest more strongly on domestic demand. The growth outlook for the export markets was assessed to have deteriorated, meaning that the contribution of net exports to growth would remain very small. The stabilisation of the oil price, the ongoing accommodative stance of money policy and the narrowing of the negative output gap were expected to support a moderate pick-up in inflation. Of external risks to euro area growth, the Bank of Finland forecast highlighted the slowdown in global growth, while, of internal risks, underscoring the fragility of growth following the protracted crisis, the refugee crisis and the UK s referendum on EU membership were seen as adding to political uncertainty. Short-term impact from Brexit vote less than expected The June Eurosystem staff macroeconomic projections revised slightly upwards the Bank of Finland activities 2016 Bank of Finland Annual Report

11 growth forecast for Inflation forecasts remained almost unchanged. At the monetary policy meeting of the Governing Council on 2 June, the risks to euro area economic activity were still viewed as tilted on the downside, but the balance of risks was seen as having improved to some extent on the back of the monetary policy measures taken and those still in the pipeline. The prospective exit of the United Kingdom from the EU (Brexit), which had been singled out as a specific risk to economic activity, materialised in June, when the majority of UK citizens (51.9% of the voters) decided at the referendum that the United Kingdom must leave the European Union. Government bond yields declined markedly in response to the outcome of the vote. At the same time, financial market risk indicators rose and stock prices fell, although they returned relatively quickly to the pre-vote level. The approximately 10% depreciation of the pound sterling appeared, in fact, to be the only visible consequence of the Brexit vote for financial markets. At its monetary policy meeting of 21 July, the Governing Council considered that euro area financial markets had recovered well from the market uncertainty triggered by the outcome of the Brexit vote. According to the assessments, the ECB s accommodative monetary policy, the announced readiness of central banks to provide liquidity, if needed, and a robust framework for bank regulation and supervision contributed to favourable financial market developments. The risks to euro area economic activity were, however, judged to still remain tilted on the downside. At the same time, the meeting laid emphasis, among other things, on the need for banks to adjust their balance sheets, and concern was voiced about the sluggish pace of structural reforms. The September ECB staff macroeconomic projections were only a little different from the June projections. Weaker export performance was foreseen than previously predicted, against the backdrop of the Brexit vote. The outcome of the vote was, however, viewed as having barely affected euro area confidence and uncertainty indicators. Inflation forecasts were kept almost unchanged. The monetary policy meetings of the Governing Council on 9 September and 10 October continued to emphasise downside risks to economic activity, although the euro area economy was considered to have shown resilience to global political and economic uncertainty, partly due to the favourable financing conditions provided by monetary policy. The most important change in the Bank of Finland forecast for the international economy published on 29 September was the assessment of the impact of the Brexit vote. Slower UK growth, particularly in 2017, was envisaged than previously predicted. Even so, euro area internal economic fundamentals were still seen as being supportive of growth in the context of monetary policy remaining accommodative for an extended period, the private sector s debt-servicing burden diminishing, near-term fiscal policies staying broadly neutral and the labour market continuing to recover. The improved economic outlook and the accommodative stance of monetary policy were also expected to gradually boost inflation. The risks were assessed to be predominantly on the downside. The main risks were seen in the prospect of rising protectionism, China s exposure to financial market disruptions because of debt-driven growth and the impact of the UK s departure from the EU. Decision to continue asset purchases at a monthly pace of EUR 60 billion Long-term inflation expectations began to rise in early September, having previously been on a downward trend throughout the year. The change was due, among other things, to inflation entering positive territory and oil price developments. Meanwhile, shorter-term inflation expectations also embarked on an upward trajectory (Chart 2). The US dollar appreciated (including relative to the euro) following the US presidential elections, as expectations of an interest rate hike in the country strengthened. The price of crude oil rose at the turn of November and December, when the OPEC countries and some non-opec oil producers reached agreement on restricting oil output. According to the Bank Lending Survey, credit standards on housing loans continued to ease in the third quarter of 2016, whereas credit standards on corporate loans remained unchanged, as opposed to the earlier trend. Credit demand also continued to grow, albeit slightly less than previously. The EAPP and the negative interest rate on 10 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

12 the deposit facility had an easing impact on credit terms and conditions. Euro area long-term government bond yields began to rise in September in the wake of developments in the United States. The Eurosystem projections for both growth and inflation changed very little in December 2016, compared with the previous, September projections. Inflation was forecast to accelerate in 2017, above all on account of the oil price performance. At its monetary policy meeting of 8 December, the Governing Council noted that the policy rates were expected to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. The main outcome of the December meeting was the decision to prolong the duration of the EAPP until the end of December 2017, with the amount of the purchases lowered to EUR 60 billion per month, starting in April The purchases may be continued beyond this deadline, if necessary, until there is a sustained adjustment in the path of inflation consistent with the inflation target. This was based on the assessment that euro area growth was firming up but inflationary pressures remained subdued. The Governing Council also considered that the risks to growth remained tilted on the downside. However, if the economic outlook becomes less favourable, or if financial market conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation, the monthly purchases can be increased during the course of To ensure the continued smooth implementation of the purchases, it was also decided to decrease the minimum remaining maturity for eligible securities from two years to one year and to permit future purchases of securities under the programme with a yield to maturity below the interest rate on the ECB s deposit facility (Chart 3). Following the December meeting, euro area long-term government bond yields began to decline and stock indices to rise. Financial market risk indicators also fell and the euro depreciated. In mid-december, the dollar strengthened further relative to the euro amid increasing divergence of monetary policy stances, as the US Federal Reserve raised interest rates and expectations of further rate hikes strengthened among members of the Federal Open Market Committee. Chart 2. Harmonised Index of Consumer Prices for the euro area % change from previous year Sources: Eurostat and Macrobond. Chart 3. Eurosystem balance sheet % of GDP Sources: European Central Bank, Eurostat, Macrobond and calculations by the Bank of Finland. Overall, the ECB s accommodative monetary policy passed through to bank lending effectively in This was reflected in falling average interest rates on new corporate and household loans and their higher annual growth rates. In particular, annual growth in the corporate loan stock picked up significantly, exceeding annual growth in the household loan stock during the latter part of the year. Monetary policy alone does not, however, suffice to generate sustainable growth. In order to reap the full benefits from monetary policy, the Governing Council called for reforms in the euro area economies to reduce structural unemployment and boost potential output growth. Going forward, fiscal policies should also do more to support economic growth, while remaining in compliance with the Stability and Growth Pact. Bank of Finland activities 2016 Bank of Finland Annual Report

13 Box 1. ECB purchase programme extended to include corporate bonds The Eurosystem began to purchase corporate sector bonds in June 2016 as part of the expanded asset purchase programme (EAPP). Purchases of corporate bonds, and the purchase programme as a whole, will continue at least until the end of As well as the Bank of Finland, five other national central banks carry out purchases of corporate bonds on behalf of the Eurosystem. To enhance the operational efficiency of the Eurosystem, the Governing Council of the ECB decided that only some national central banks would carry out purchases of corporate bonds. Although corporate bonds do not differ in terms of their modalities from government bonds yielding coupon interest, operating on the corporate bond market requires special skills. The Bank of Finland has already accumulated such competence over a couple of decades of investing its own financial assets in corporate bonds. Besides the Bank of Finland, the central banks of Germany, France, Spain, Belgium and Italy purchase bonds issued by nonfinancial corporations in their respective countries. The Bank of Finland also purchases bonds issued by Irish, Austrian and Baltic non-financial corporations. Chart. Euro area corporate bond spreads declined % points years, BBB-rated 2. 3 years, AA-rated Source: Macrobond. ECB Governing Council announces inclusion of corporate bonds in the programme Meanwhile, the Belgian central bank operates under the programme on the Portuguese, Luxembourgian, Slovakian, Slovenian, Cypriot, Maltese and Dutch markets. Given that many international corporations active in different European countries issue their bonds in the Netherlands, the country s corporate bonds are divided among the large central banks involved in implementing the purchase programme, mainly according to the country in which these corporations actually operate. Only some corporate bonds are eligible for purchase under the programme. The criteria are based on the Eurosystem s collateral framework for monetary policy operations. In particular, the requirement for a public credit rating excludes even large corporations from the programme: for a corporate bond to be purchased, at least one eligible public credit rating agency must rank the bond as belonging to the investment grade, which is equivalent to a rating of BBB. Moreover, corporate bonds must be denominated in euro, and they must have a minimum remaining maturity of six months and a maximum remaining maturity of 30 years at the time of purchase. As there are many large international corporations operating in the euro area, the parent undertaking of such a corporation may be located outside the euro area. By contrast, banks and other credit institutions or those corporations whose parent undertaking is a credit institution are excluded from the programme. Bonds issued by public sector undertakings are eligible, but the limits for their purchase are mainly similar to those applied in the public sector purchase programme. For example, bonds issued by public sector undertakings are not purchased directly from the issue. The Eurosystem purchases corporate bonds on both primary and secondary markets. Typically, a small number of banks are responsible for debt issues on behalf of non-financial corporations. The Bank of Finland competes on this market as one investor among others. The Bank of Finland purchases securities from its own counterparties, i.e. Finnish and international banks. 12 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

14 By the end of 2016, the Eurosystem had purchased corporate bonds to the value of EUR 1.5 billion. To maintain market liquidity, Eurosystem central banks also lend corporate bonds they have purchased. Published securities lending lists show that Eurosystem purchases are broadly aligned across different sectors and different Member States. Bonds of energy and infrastructure corporations have been the most purchased, due to the fact that, in representing capital-intensive sectors, they finance their investments on the markets. The corporate sector purchase programme supplements the EAPP, which is allocated across public sector securities, covered bank bonds and asset-backed securities (ABSs). The corporate sector programme will further strengthen the broadly based transmission of monetary policy and ease the corporate sector s financing conditions, thereby accelerating euro area inflation rates to levels consistent with the objective of price stability. The announcement of the launch of corporate bond purchases brought down corporate bond spreads by 0.20 of a percentage point (Chart). When corporate bond yields fall, the corporate sector s financing costs and requirements for return on investment decline. The purchase programme encourages corporations to seek market funding, which stimulates euro area capital markets and offers an alternative funding channel to traditional bank finance. The future of the euro area was discussed at the Bank of Finland Museum in October after an introductory talk by Professor Markus Brunnermeier. Photo: Peter Mickelsson. Bank of Finland activities 2016 Bank of Finland Annual Report

15 Implementation of monetary policy in the euro area and Finland In the Eurosystem, the national central banks implement the monetary policy decisions of the ECB Governing Council in a decentralised manner. The traditional system for implementation of monetary policy includes market operations, standing facilities and a minimum reserve system. Counterparties place collateral with the central bank for the market operations, which are executed in the form of refinancing operations. In 2016, the Eurosystem s expanded asset purchase programme (EAPP) was extended and corporate bonds were also included in the programme. The Bank of Finland is responsible for national implementation of the Eurosystem s single monetary policy. Credit institutions located in Finland hold current accounts with the Bank of Finland and participate in monetary policy operations through the Bank. In addition, the Bank of Finland carries out its own share of the Eurosystem s outright trans actions. Monetary policy further relaxed In 2016, the Eurosystem continued to relax its monetary policy. In addition to an accommodative interest rate policy, the Eurosystem expanded its non-standard monetary policy measures. The ECB Governing Council decided to include purchases of corporate bonds in the expanded asset purchase programme from the beginning of June The Bank of Finland is one of six national central banks responsible for implementation of the programme (Box 1). The expanded asset purchase programme increased the amount of securities held by the Eurosystem. At the same time, the excess liquidity in the euro area banking system rose to more than EUR 1,200 billion. Chart 4. Excess liquidity in the euro area banking system EUR billion 1,400 1,200 1,000 In January March, the asset purchases increased the amount of liquidity by about EUR 180 billion, and from April onwards by EUR 80 billion a month (Chart 4). Alongside its non-standard measures, the Eurosystem continued to conduct its main refinancing operations and regular three-month longer-term refinancing operations as fixed-rate tenders with full allotment. In accordance with the decision of the Governing Council in December 2015, fixed interest rate and full allotment will be applied in these standard refinancing operations at least to the end of the last reserve maintenance period of The amount of financing allocated in the weekly main refinancing operations decreased as the year advanced and then settled around EUR 35 billion. The amount of outstanding credit in the monthly refinancing operations with a maturity of 3 months decreased from EUR 50 billion at the beginning of the year to EUR 13 billion. The Governing Council decided to continue one-week dollar-denominated refinancing operations with allotments varying between zero and EUR 6.3 billion Excess liquidity* day moving average * Reserve deposits minimum reserve requirements + overnight deposits overnight credit via the marginal lending facility. Source: Bank of Finland. New series of targeted longer-term refinancing operations In March, the Governing Council decided to conduct a series of new targeted longer-term refinancing operations (TLTRO II), in which banks are offered longer-term financing on favourable terms (Chart 5). In these operations, banks in 2016 applied for an aggregate financing amount of EUR billion. The total number of operations will be four, and they will be conducted on a quarterly basis starting from June The maturity of all the new operations will 14 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

16 be 4 years, and premature repayment of the allotted financing may be started after two years at the earliest. Three of the operations were conducted in The fixed interest rate of the targeted longer-term refinancing operations is the interest rate of the main refinancing operations on the allotment day of the targeted operation in question. However, the interest rate may fall all the way to the level of the ECB deposit facility if the bank that has applied for financing fulfils the conditions for increased lending to the private sector. As many as 514 banks or bank groups participated in the targeted longer-term refinancing operation conducted in June Participants in the September operation numbered 249, while in December the figure was 200. Of the aggregated allotment in TLTRO I and TLTRO II, credits amounting to EUR 545 billion were outstanding at the end of Of the outstanding credits, TLTRO I operations represented EUR 39 billion and TLTRO II operations EUR 507 billion. Amount of collateral placed with Eurosystem no longer decreasing Credit from the central banks in the Eurosystem requires that banks provide sufficient collateral assets that fulfil the eligibility criteria of the Eurosystem. The decrease in the amount of collateral that had started in 2013 came to a halt in the second half of 2016, settling at the same level as at the end of the previous year, EUR 1,658 billion (Chart 6). This trend is due to a stabilisation of banks borrowing from the Eurosystem. In 2016, collateral at an average amount of EUR 1,665 billion was provided to the central banks in the Eurosystem, as compared to an average of EUR 1,750 billion in Since the amount of credits was only slightly higher in 2015 and the amount of collateral remained unchanged, most of the collateral still constituted a surplus. Banks do not have much need for the refinancing operations due to the excess liquidity brought about by the purchase programmes. In 2016, debt instruments issued by the public sector, i.e. central and regional government (23%), were still the joint most common type of collateral provided by banks. Bank loans (also 23%) were the 1,500 1,250 1, ,000 Chart 5. Eurosystem monetary policy operations EUR billion Longer-term refinancing operations (3 months) 2. Supplementary longer-term refinancing operations (1 12 months) 3. Main refinancing operations (1 week) 4. Net recourse to standing facilities (overnight) 5. Fine-tuning operations (1 7 days) 6. Supplementary longer-term refinancing operations (36 months) 7. Targeted longer-term refinancing operations Source: Bank of Finland. Chart 6. Collateral provided to the Eurosystem EUR bn 3, ,500 2,000 1,500 1, Securities issued by central government 2. Securities issued by regional government 3. Uncovered bank bonds 4. Covered bank bonds 5. Corporate bonds 6. Asset-backed securities 7. Other marketable assets 8. Non-marketable assets* 9. Credit claims* 10. Fixed-term deposits* * Breakdown only available from 2013 onwards. Source: European Central Bank /I 2013/II 2013/III 2013/IV /I 2014/II 2014/III 2014/IV /I 2015/II 2015/III /I 2016/II 2016/III 2016/IV 2015/IV Bank of Finland activities 2016 Bank of Finland Annual Report

17 Chart 7. Liquidity deposits with the Bank of Finland EUR bn % Use of deposit facility 2. Fixed-term deposits 3. Current account balances exceeding reserve requirements 4. Share in Eurosystem deposits (right-hand scale)* * Includes use of deposit facility, fixed-term deposits and current account balances exceeding reserve requirements (average over reserve maintenance period). Sources: European Central Bank and Bank of Finland. Chart 8. Collateral provided to the Bank of Finland (averages for 2016) % 3 20% 10% 1% 22% 35% 1. Central and regional government securities 2. Covered bank bonds 3. Uncovered bank bonds 4. Corporate bonds 5. Other marketable assets 6. Non-marketable credit claims Source: Bank of Finland other leading category. Banks covered bonds and asset-backed securities came next, both with a share of 19%. Bank of Finland s counterparties increasingly active in monetary policy operations During the year, no changes occurred in the group of counterparties engaged by the Bank of Finland for monetary policy refinancing and deposit operations. The counterparties number 16 and include Finnish credit institutions and Finnish branches of Nordic credit institutions. The growing liquidity surplus was also reflected in the deposits by the Bank s counterparties, which increased considerably from the previous year. Counterparties can transfer their reserve holdings in excess of the minimum reserve requirement into the deposit facility or leave them in their current accounts with the central bank. The interest rate paid on all funds exceeding the minimum reserve requirement is the ECB deposit facility rate. In 2016, this interest rate was negative. In 2016, Bank of Finland counterparties total reserve holdings in excess of the minimum reserve requirement averaged EUR 67 billion, compared with EUR 27 billion in 2015 (Chart 7). Finland s share of the reserve holdings in excess of the minimum reserve requirement in the entire Eurosystem also increased rapidly early in the year and then settled towards year-end. On average, the share was 7%, which is a significant share in relation to the size of the Finnish economy. Regardless of the liquidity surplus, the counterparties of the Bank of Finland participated in the refinancing operations more actively than in 2015, in particular in the targeted longer-term TLTRO II operations. The amount of outstanding monetary policy credits in Finland averaged EUR 2.6 billion, compared with EUR 670 million in the previous year. Most of the outstanding credits had been allocated in the TLTRO II operations that commenced in June. Eight counterparties participated in the operations. The amount of collateral provided by the counterparties of the Bank of Finland still clearly exceeded the allotment in the refinancing operations, although the total amount of collateral also declined in 2016, 16 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

18 by around EUR 3.7 billion to around EUR 17.9 billion. The more active participation by counterparties in the monetary policy operations affected the distribution of collateral according to credit needs. An average of 15% of the total amount of collateral was used as collateral for monetary policy credits, which is well above the 3% share in On the other hand, the limit for intraday credit maintained by the counterparties for handling payment transactions tied up 61% of the collateral, whereas 70% of the total amount of collateral was needed for this in The collateral surplus averaged 25%. The most common type of collateral provided was covered bonds (35%), although their share decreased from the 43% share in 2015 (Chart 8). The second most common collateral was debt instruments issued by central and regional government (22%), while third came nonmarketable credit claims (20%), whose share increased significantly from the previous year (13%). The Bank of Finland and economic policy in Finland In 2016, the Bank of Finland analysed developments in both the domestic and the global economy and participated in economic discourse in Finland in a variety of ways. The members of the Bank of Finland Board and experts from the Bank were consulted on several occasions by Parliament and also presented their assessments in other domestic fora. When decisions on economic policy were taken in 2016, economic conditions in Finland were better than the year before, but still weak. GDP was still 4% lower than in In 2016, economic growth hinged exclusively on domestic demand, amid subdued export performance. While unemployment lessened, the employment situation and the fiscal situation remained constrained. The Bank of Finland pointed out that the monetary policy pursued by the ECB had improved the preconditions for economic growth in Finland, too. Monetary policy supported the euro area economy and, by extension, Finnish exports to other euro area countries. The euro area s share of Finland s total exports continued to grow. At the same time, the monetary policy measures lowered financing costs in Finland, thereby strengthening the preconditions for growth in domestic demand. Labour productivity growth remained subdued overall in the advanced economies, with the long-term growth outlook clouded by uncertainties. Over the next 15 years, Finland, too, will experience slow economic growth compared with past decades. This presents a threat to the funding of the welfare state and highlights the importance of measures designed to strengthen fiscal sustainability. The long-term sustainability of Finland s public finances not being secured threatens a difficult future for the current generation of young people, who will have to bear not only the costs of caring for the older generation and most of their pensions, but also the costs stemming from the rapidly growing public debt. In addition to public debt, household debt also continued to expand in The rising household debt ratio is a well-justified concern against the backdrop of the subdued longer-term growth outlook compared with previous decades. As regards the management of the risks involved in household indebtedness, the Bank of Finland emphasised the importance of macroprudential policy and housing policy. As before, the Bank underlined the importance of structural reforms that improve growth prospects and the fiscal balance, and of measures that restore costcompetitiveness. Major steps forward have been taken with the pension reform and the Competitiveness Pact, but more still needs to be done. One important sector of structural policy relates to fostering competition. The role of economic policy is to create a level playing-field for different sorts of companies and a positive environment for the birth of new enterprises and the growth of all sorts of companies. The uncertainties of the global economy relate largely to political decisions. In many countries, the supporters of free trade and other international cooperation have been forced onto the back foot. At the same time there is a great need for international cooperation if we are to manage the problems with climate change, the refugee situation and the economy. Behind the political uncertainties could in part lie the deteriorating income Bank of Finland activities 2016 Bank of Finland Annual Report

19 development of many households and growing inequality in the advanced economies. Factors underlying the structural changes experienced in the advanced economies in recent decades include technological change and globalisation. While having generated a great deal of economic well-being, they have also created a greater need to manage the economic impact of these trends within the advanced economies. The Bank of Finland emphasised that policy choices should be devoted to supporting the successful adaptation of economies to new circumstances, while at the same time caring for those whose economic position has been weakened. The educational system has a key role to play in combating inequality, particularly over the longer term. Domestic forecasting in 2016 After several weak years, the Finnish economy returned to growth in 2016, with domestic demand as the engine of growth. During 2016, growth strengthened particularly on the back of private consumption and investment recovery. By contrast, exports continued to perform sluggishly and export demand remained weak. Private consumption has been the main driver of growth ever since Private consumption has been buoyed by low inflation and an accommodative monetary policy. Purchasing power has also been sustained by a sharp increase in public transfers. Investment growth clearly began to take off already in In addition to a pick-up in residential construction investment, productive investment also grew. Still, the GDP share of productive investment has remained modest. In recent years, total Finnish exports have not grown as expected, lagging behind the trend in the export markets. Reduced industrial capacity and problems caused by deteriorated cost-competitiveness have kept export growth extremely modest. At the same time, low global investment and uncertainties in the international economy have eroded export prospects. The labour market situation in Finland improved in 2016, reflected in a rapid reduction in unemployment. However, the labour market recovery was slowed by structural problems, with long-term unemployment in particular remaining high. The unemployment rate dropped sharply in 2016, but improvement in employment has been more difficult. Finland s fiscal situation remains challenging despite the major consolidation measures adopted in recent years. The general government deficit is large, and public debt has grown at a rapid pace. Attainment of more balanced public finances is hampered not only by high unemployment-related and other social security expenditure but also by rapid growth in age-related spending and low economic growth. There is a significant and long-term structural problem with Finland s public finances that cannot be explained by cyclical factors alone. The sluggishness of the economy in recent years, together with sharp declines in energy and commodities prices, have kept inflation low. Inflation according to the harmonised index of consumer prices (HICP) was just 0.4% in According to the Bank of Finland forecast in December 2016, GDP will continue to grow in , driven mainly by domestic demand, but will remain subdued, at a good 1% per annum, relative to previous cyclical upswings. The Competitiveness Pact concluded in 2016 will curb increases in average earnings and unit labour costs in More subdued developments in costs will boost growth in investment, exports and GDP. Improved cost-competitiveness and the recovery of export markets will see Finnish exports return to growth. These favourable developments are, however, clouded by growing uncertainties in the international economy. Investment growth will be strongest in , fuelled particularly by construction. Low interest rates and the availability of funding will strengthen the investment environment. In the second half of the forecast period, the growth rate will level out, in response to a moderation in construction activity. Productive investment will also trend up, but its share of GDP will be lower than usual. The continued accommodative stance of monetary policy and strong consumer confidence will boost private consumption, particularly early in the forecast period. Indeed, in the immediate years ahead private consumption will remain the major 18 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

20 factor contributing to economic growth in Finland. The increase in households real income will be driven by gradual improvements in employment and persistently low inflation. The number of people employed will increase, with the employment rate rising as unemployment falls. The outlook for the public finances in the immediate years ahead is particularly affected by government decisions on expenditure adjustments and the Competitiveness Pact. Fiscal policy will ease in 2017 with the entry into force of the cuts in taxes and social security contributions decided in connection with the Competitiveness Pact. The general government deficit will, however, remain large, and public debt will continue to grow at a rapid pace in The Bank of Finland forecasts were revised up over the course of In the light of preliminary National Accounts data, economic growth turned out to be faster than projected in late However, growth has increasingly hinged on domestic demand. Private consumption in particular has been robust, while investment growth has been brisk in response to a revival in construction activity. By contrast, export growth remained somewhat weaker than projected. In response to the Competitiveness Pact and more subdued developments in costs, forecasts for 2017 have also been revised slightly up. The risks to the forecast, however, remain tilted on the downside. Photo: Peter Mickelsson. Bank of Finland activities 2016 Bank of Finland Annual Report

21 Financial system One of the tasks of the Bank of Finland is to analyse vulnerabilities that warn of financial crises and examine the effects of macroprudential tools. The Bank also participates in the preparation of measures for preventing financial crises. In its stability reports, the Bank of Finland has assessed the short-term stability risks to the financial system as small, but it has drawn attention to the increase in household debt accumulation and the vulnerabilities of the Finnish banking system. The Bank has also emphasised the need to complement the macroprudential tools currently available. The Governor of the Bank of Finland is a decision-maker on the General Board of the European Systemic Risk Board (ESRB), an EU body within the European System of Financial Supervisors (ESFS). The ESRB analyses risks to the financial system in the EU and issues warnings and recommendations to national authorities for measures to enhance stability. In 2016, the ESRB issued a warning to eight EU countries. For example, it issued a warning to Finland on medium-term vulnerabilities in the residential real estate sector. The Governing Council of the ECB also deals with questions relating to financial stability. Bank of Finland experts participate in the work performed within committees and working groups of the ESRB and the ECB. Financial stability The average profitability of the euro area banking sector remained under pressure in In addition to challenges related to an operating environment with low interest rates, banks profitability has also been eroded by the protracted structural problems in the banking sector. In several euro area countries, the banking sector is quite large relative to the size of the economy, and is inefficient. Moreover, some countries banks are burdened by the considerable amount of bad loans on their balance sheets. Despite the problems facing the euro area banking sector, banks lending capacity improved in 2016, the ECB s accommodative monetary policy fed through to bank lending and the rate of growth in household and corporate lending picked up in the area during the course of the year. In its stability assessments, the Bank of Finland has in recent years drawn attention to the increase in household debt and the uneven distribution of this debt, as well as to structural vulnerabilities in lending for house purchase. In the assessment of the Bank, notwithstanding the vulnerabilities, there are no signs of short-term threats to the stability of the Finnish financial system. The European Systemic Risk Board issued a warning to Finland on medium-term vulnerabilities related to household indebtedness and the residential real estate sector (see Box 2). To forestall these risks, it is essential to ensure that authorities have access to a broader set of macroprudential tools to influence household debt accumulation and the related systemic risks. The structural vulnerabilities of the Finnish banking system have remained significant. Finland s banking system is among the most concentrated in the EU: the two largest banks account for nearly two-thirds of both deposits and lending. Banks are dependent on market-based funding and bond funding acquired mainly from the international financial markets. Housing loans account for a considerable share of banking sector lending, and the risk weights for housing loans are low, which benefits the banks in their capital adequacy calculations. The vulnerability to the housing market of banks operating in Finland is further increased by their interconnectedness with the Nordic banking systems. Banks operating in Finland: strong capital adequacy and small impairment losses Despite the difficulties in the operating environment, the situation of the Finnish banking sector has remained stable. Banks capital adequacy is solid on average, and despite a moderate weakening, their profitability has remained relatively good. Banks net interest income declined in January September 2016 by approximately 20 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

22 7%. They have been able to compensate part of this decline by, for example, increasing their net fee income somewhat. Despite the slight weakening in profitability, banking sector capital adequacy remained strong in The Finnish banking sector s capital position has long been characterised by a high CET1-to-own funds ratio. The quality of lending in the Finnish banking sector has remained good. At the end of September 2016, non-performing assets accounted for 1.5% of total assets (12/2015: 1.5%). The non-performing assets of banks operating in Finland are among the lowest in the EU, as the average ratio for the EU over the corresponding period was over 5%. Banks impairment losses remained small in 2016 (less than 0.1% of the credit portfolio). The leverage ratio of Finnish banks was 5.5% at the end of September 2016 (12/2015: 5.7%), which is already now significantly higher than the minimum requirement (3%) proposed by the Basel Committee on Banking Supervision. New FinTech companies which utilise digital innovations and new, constantly developing information technology solutions are challenging the banking sector with their new operating practices, particularly with payment and investment services. These new entities create new challenges to banks traditional business models, and the entry of competitors to the market puts pressure on banks profitability. Technological advances enable the introduction of new operating practices in the financial sector. Financial sector structures have traditionally been fairly rigid, and changes have taken a long time. Moreover, financial market infrastructures have been in the hands of large operators, and new players have faced difficulties in entering the market. Digitalisation does, however, offer a considerable potential for change, which may reshape current financial market infrastructures. Thus far digitalisation has primarily affected the operating processes of banks and other financial sector entities, and structural changes have been minor. The effects of digitalisation are reflected in, for example, shifts in consumers payment habits and a decrease in the use of cash. Banks role in financial intermediation may Table 1. Banking sector capital adequacy Average Core Tier 1 capital ratio, % also diminish in future. The value chain of financial intermediation nowadays includes alternative providers of funding, such as brokers of crowdfunding or peer-to-peer loans. The Bank of Finland, in cooperation with commercial banks and other financial sector entities, is innovating and developing efficient methods of payment, for example in the Payments Council and its working groups (see Financial market infrastructure, p 26). Growth in private sector bank credit unchanged from previous year The pace of growth in household debt remained unchanged in 2016 compared with the previous year. In December, the stock of household loans and the stock of housing loans grew by 2.4% year-on-year (in 2015: 2.5%). In recent years, a slight change has taken place in the nature of households housing finance. The rate of growth of bank loans to housing corporations is higher than that of housing loans to households. The annual growth rate of loans by housing corporations was in September 2016 slightly over 10% (9/2015: 18.6%). The indicator of household debt i.e. debt relative to disposable income has continued to rise. In September 2016, the debt ratio was 126.9%, compared with 123.8% a year earlier. Reflecting the low level of interest rates, the debt-servicing capacity of households has remained relatively good, despite the higher debt ratio. Finnish non-financial corporations access to bank funding is still among the best in the euro area: surveys on the access to finance show that of the companies that applied for a bank loan, approximately September Total capital ratio, % Source: Financial Supervisory Authority. Bank of Finland activities 2016 Bank of Finland Annual Report

23 80% were granted the loan in full or for most of the amount applied for. Surveys on companies access to finance (SME barometer) indicate a tightening of terms and conditions of access to finance by SMEs that are involved in global trading and growth-oriented. Collateral requirements have tightened and the use of loan covenants has increased. The average interest rate on the stock of loans by Finnish non-financial corporations (incl. housing corporations) declined in In December 2016, the average interest rate on the loan stock was 1.47% (12/2015: 1.63%). The imputed margins of new corporate loans are, however, on a slight upward trend. The annual growth rate of drawdowns by non-financial corporations (incl. housing corporations) slowed in 2016: in December, the annual growth rate of corporate loans was 4.6%, compared with over 5% a year earlier. Financial system policy The Bank of Finland supports financial stability by, for example, participating in the preparation of macroprudential policy and decision-making in Finland, and in a broader context, in the euro area and the European Union (see Box 3). In addition, the Bank develops the necessary crisis management capabilities in cooperation with domestic and international authorities and supports the development of financial regulation and supervision. The purpose of macroprudential policy is to prevent financial crises that threaten the stability of the entire financial system. In Finland, decisions on the use of macroprudential tools are taken by the FIN-FSA Board. As part of the preparation of macroprudential decisions, the Bank of Finland delivered in 2016 four opinions on proposals by the Director General of the FIN-FSA for the deployment of macroprudential tools. In June 2016, the FIN-FSA Board decided to take measures to introduce a minimum level for the average risk weight on housing loans. In its opinions, the Bank of Finland supported these measures and emphasised the need to implement them in full, in accordance with the decision. Due to the weak economic cycle, it was not necessary in 2016 to impose a counter- cyclical capital buffer requirement on credit institutions. In its opinions, the Bank of Finland did, however, underscore the need to monitor the pace of growth in the credit stock and particularly developments on the housing loan market, and to prepare to raise the additional capital requirement, if necessary. In addition, the Bank proposed that changes be considered in the method of calculating the maximum loan-to-value ratio that entered into force in July In Finland, the maximum loan-to-value ratio limits the amount of housing loan relative to collateral, not relative to the value of the housing, as in many other countries. The Bank of Finland also highlighted the need to introduce in Finland macroprudential tools for ensuring the ability of households to service their debt. The lack of this type of tool was also identified by the European Systemic Risk Board in the warning it issued to Finland (see Box 2) and by the International Monetary Fund in its financial system stability assessment. The macroprudential toolset also currently lacks a systemic risk buffer requirement for the prevention of risks caused by the structure of the banking system; the Bank of Finland has supported the incorporation of this requirement into legislation. The Ministry of Finance started preparing the required amendment to legislation in For the development of crisis management capabilities, international cooperation is important, as the Finnish banking sector is closely interconnected with the Nordic and Baltic banking systems saw renewal of the Memorandum of Understanding between the central banks of these countries. The MoU enhances central banks capabilities for cooperation in the supervision of financial stability and crisis management. The macroprudential forum of the national central banks and financial supervisory authorities of these countries is also working actively. The need for cooperation is underlined by the conversion in 2017 of Nordea Bank Finland from a subsidiary into a branch of the Swedish parent bank. EU-level cooperation for fostering financial stability is described in more detail in Box Bank of Finland Annual Report 2016 Bank of Finland activities 2016

24 Box 2. The European Systemic Risk Board issued a warning on vulnerabilities in the residential real estate sector The European Systemic Risk Board (ESRB) issued in autumn 2016 a warning to several EU countries on vulnerabilities related to the residential real estate sector and household debt. Housing market bubbles and excessive household indebtedness are among the most important factors underlying financial crises, and therefore further measures for improving the capacity to forestall these risks must be considered in Finland, too. The ESRB issued in November 2016 to Finland and seven other EU countries a warning on medium-term vulnerabilities in the residential real estate sector. The warning issued to Finland focused on the already high and increasing level of household indebtedness. The ESRB noted that policy measures have already been implemented in Finland to mitigate the risks, but they may not be sufficient to fully address them. Why is the ESRB concerned about household indebtedness? The task of the ESRB is to issue warnings and recommendations to enhance financial stability. In the countries that were warned about vulnerabilities in the residential real estate sector, household debt levels are historically high by both the countries own standards and European standards. A high level of indebtedness weakens households ability to adapt in an event of weaker than expected economic developments. In a downturn, this increases the risk of higher credit losses and a reduction in consumption, leading to a further contraction in the economy. Many researchers of banking crises have come to the conclusion that price bubbles on the housing market are one of the most important leading indicators of crises. Expectations on further increases in the value of residential real estate feed the price bubble. These expectations are based mainly on developments in the recent past, and this trend is assumed to continue. A person may purchase housing only with the purpose of selling it for a higher price at a later stage, whereas other homebuyers want to avoid paying an even higher price in future. Strong demand naturally pushes up prices, as the volume of housing does not grow in line with demand, at least not in the short term. As a result, the rise in prices turns into a self-reinforcing spiral. It is often difficult to distinguish a bubble from a rise in housing prices that is emanating from permanent constraints on housing supply or a strengthening of demand due to factors other than expectations of higher housing prices. Price bubbles contribute to unsustainable debt accumulation. In an environment of high prices, banks can increase their lending activities in a seemingly safe manner if real estate collateral is valued at the sales price at a given time. In many of the countries that were warned by the ESRB, the maximum size of the housing loan is tied to the price of the residential property in the case of Finland, to the value of collateral, in a broader sense but not to, for example, the loan applicant s income, which normally would not grow due to the price bubble. As a result, the ESRB considers that the measures available for curbing household indebtedness are insufficient in many of the countries concerned. If there is a price bubble, collateralised loans will turn out to be a threat to financial stability and the safety provided by the collateral merely ostensible if a large group of debtors is unable to service their loans with their income. Housing supply increases as insolvent debtors are forced to realise their residential property. There may be a considerable number of forced sales of residential real estate, which will finally burst the bubble. House price trends differ considerably between countries and regions. In some of the countries that were warned, residential real estate prices have risen at an alarmingly rapid pace, particularly in the large cities. In some countries, households have also acquired large volumes of new housing debt. In Finland, the main problem is household indebtedness. If the risks related to the housing market were to materialise they could spread across countries, via international trade and banks. The vulnerabilities of Nordic banks are increased by the banking sector s structural specificities, for example the high degree of concentration, interconnectedness and dependence on market-based funding. Bank of Finland activities 2016 Bank of Finland Annual Report

25 Box 3. The Bank of Finland s role in the macroprudential system Macroprudential policy refers to not only macroprudential supervision, but also particularly to actions for preventing systemic risks, with the objective of ensuring the stability of the financial system as a whole. Within banking union, responsibility for macroprudential policy is divided between the ECB and national authorities. The task of the ECB is to assess the measures taken by the national authorities and to tighten them, where necessary. In the case of Finland, the decision-making powers of the ECB cover all the macroprudential tools, with the exception of the maximum loan-to-value ratio (LTV) defined in national legislation. On macroprudential issues, decisions of the ECB are taken by the Governing Council. The banking supervision and macroprudential perspectives are brought together in the Macroprudential Forum. This comprises the members of the Governing Council of the ECB and the Supervisory Board of the Single Supervisory Mechanism. The European Systemic Risk Board (ESRB) is responsible for macroprudential oversight of the financial system of the European Union. Its task is to issue macroprudential policy recommendations and warnings. The Financial Stability Committee (FSC) of the European System of Central Banks (ESCB) supports the Governing Council of the ECB and the Macroprudential Forum. On the Committee, the ECB and the national authorities make joint risk assessments and coordinate their policies. The work of the ESRB is, in turn, supported by its Advisory Technical Committee and Advisory Scientific Committee. The system is so extensive because macroprudential policy cannot be assessed separately from banking supervision and monetary policy, due to the close connection between these three components. Via the committees of the ESCB and the ESRB, Bank of Finland experts participate in the preparation and long-term development of macroprudential policy. Bank of Finland experts also conduct targeted research and apply international research and experience in practice. In Finland, macroprudential decisions are taken by the FIN-FSA Board. This is a natural place for decision-making, as all the relevant Finnish authorities are represented on the Board together with independent members. In line with established practice, the decisions are taken separately from micro-level decisions. The ECB has separate processes for monetary policy, banking supervision and macroprudential policy decision-making. Macroprudential policy decisions are prepared in cooperation by Bank of Finland and FIN-FSA experts. The Bank of Finland is responsible primarily for macroprudential analysis, whereas institution-specific microprudential analysis is the responsibility of the FIN-FSA. Both analyses are part of the preparation of macroprudential policy. At the Bank of Finland, preparation takes place in the internal financial stability policy process. This is conducted on a quarterly basis, as legislation requires that macroprudential decisions are taken on this frequency. The process produces a macroprudential report containing an analysis of systemic risks and, based on this analysis, a recommendation by experts for action to be taken. Based on this information, Bank of Finland, FIN-FSA and Ministry of Finance experts assess the need for macroprudential policy action. The FIN-FSA s Director General presents a proposal on macroprudential policy to the FIN-FSA Board for decision. In addition to the Bank of Finland and the Ministry of Finance, the Ministry of Social Affairs and Health also expresses an opinion on the proposal. Subsequently, the FIN-FSA consults with the ECB regarding the decision. The Bank of Finland has the right to issue a proposal to the FIN-FSA Board for decision. All decisions taken and their grounds as well as comprehensive background material are published on the FIN-FSA website. The extensive preparations ensure that the decision-making bodies have all necessary information at their disposal. It was a conscious decision to build such a multi-layered macroprudential system on the domestic level and within the 24 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

26 Banking Union. The purpose is to also facilitate difficult and unpopular decisions. The multi-layered structure requires effective preparation, in cooperation between the relevant authorities. The Bank of Finland and its experts play an active role in macroprudential policy within the Banking Union and in the domestic context. As the Bank of Finland is neither the regulator nor the supervisor of financial institutions, it can make independent technical preparations to support policy decisions. The work is based on extensive analysis by the Bank, focusing on the interaction between the financial system and the macro economy and an assessment of the impact of this interaction on financial stability. In June, the Bank of Finland organised the Economic and Financial Committee (EFC) meeting in Helsinki. Photo: Peter Mickelsson. Bank of Finland activities 2016 Bank of Finland Annual Report

27 Financial market infrastructure Maintaining the reliability and efficiency of the payment and financial system is one of the Bank of Finland s statutory tasks. The Bank of Finland therefore takes an active part in oversight cooperation between domestic and international market infrastructures. The Bank of Finland participates in the development of payment systems via, for example, the work of the Payments Council. The Payments Council is a domestic cooperation body that brings together both users and providers of payment services and the relevant authorities. In 2016, an e-book entitled How do we pay in the 2020s? Perspectives on future payment solutions was published as a Payments Council initiative; this was a first for the Payments Council. The book brought together the views of different stakeholders in the area of payments on visions for the future payments landscape. During the year, the Payments Council also conducted an analysis entitled Käteistä kaupan kassalta ( Cash from the checkout ), exploring the possibilities of cash distribution directly via retailer terminals (known as cashback services). Meanwhile, the Payments Forum presents annually the work of the Payments Council. In 2016, the Forum was organised for the tenth time, attracting well over 150 experts to reflect on the possibilities and challenges for payments. This time, the themes were digitalisation and financial technology (fintech). In addition, a panel discussion on the future payments environment was organised on the basis of the Payment Council s e-book. During the year, the Bank of Finland collected payment statistics from payment and credit institutions and payment system operators on the basis of the ECB Regulation on payment statistics. The data are used for payment system monitoring and were published on the Bank of Finland website and, in greater detail, on the ECB website. The Bank of Finland joined as user the pan-european securities settlement platform, TARGET2-Securities (T2S) in September 2016, and has since been providing T2S liquidity management services to domestic market participants (see Payment system services ). European central securities depositories and central banks are due to become platform users in several different stages. The Bank of Finland, in cooperation with the Financial Supervisory Authority, is closely monitoring the project of the Finnish Central Securities Depository, Euroclear Finland, and of the Finnish market for migration to T2S. Throughout the 2000s, the Bank of Finland has maintained and upgraded its BOF-PSS2 Payment and Settlement System Simulator, which is used worldwide as a quantitative analysis tool. As usual, in August the Bank of Finland organized, already for the 14th time, an international simulator seminar, attended by researchers from several different continents. The simulator is in a process of ongoing improvement so as to better meet user requirements, and in 2016 work was done to develop, among other things, a component simulating central counterparty activity. Payment system services The Bank of Finland provides payment system services to banks via its TARGET2 component, TARGET2-Suomen Pankki. Overall, the TARGET2 system, owned and operated by the Eurosystem, functioned reliably in The aggregate value of payments processed in TARGET2-Suomen Pankki during the year increased, while their volume remained at the level of the previous year. An average of 1,600 payments per day were processed. The aggregate value of these payments was approximately EUR 43 billion (Chart 9). These account for 0.4% of the volume and 2.3% of the value of payments processed in TARGET2 as a whole. TARGET2-Suomen Pankki had 23 direct participants at year-end, of which three were ancillary systems. At the end of 2016, TARGET2 as a whole had some 1,000 direct participants connected to the system through 25 central banks components. The Bank of Finland also uses its own collateral management system (BoF-CMS- Cola) for providing collateral management services to its customers. During the course of 2016, the system was operationally reliable, managing EUR 18 billion worth of collateral assets, on average. The use of the system has furthered digitalisation by 26 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

28 Chart 9. Daily average volume and turnover of TARGET payments processed for TARGET2-Suomen Pankki system participants Number 2,400 2,000 1,600 1, Volume of payments (left-hand scale) 2. Turnover (right-hand scale) Source: European Central Bank. automating functionalities, including reporting and filing. In September 2016, the Bank of Finland joined the European securities settlement platform (TARGET2-Securities, T2S) as a user and simultaneously commenced the provision of liquidity management services to those of its customers that had been the first to register as T2S users. The number of banks using T2S via the Bank of Finland will increase in connection with the upcoming migration waves. In the context of its own T2S project, the Bank of Finland pursued close cooperation with customers and Euroclear Finland by carrying out tests and training customers with a view to ensuring successful T2S migration. During 2016, the Bank of Finland fostered dialogue with the markets, both within national user groups and at bilateral meetings, while functioning as a point of contact for the ECB and actively participating in work at committee and working group level. In addition to T2S preparations, the Bank s work focused particularly on the development of future payment system services. EUR bm Professor Bengt Holmström was the first Finn to be awarded the Nobel Prize for economic sciences. Professor Holmström is an active debater and has also spoken at the Bank of Finland Museum. Photo: Peter Mickelsson. Bank of Finland activities 2016 Bank of Finland Annual Report

29 Box 4. Payment methods facing major overhaul Digitalisation is creating opportunities and reshaping existing practices in the different sectors of the economy. The new operating procedures it brings are also visible in the sphere of payments. In the past ten years, the ease of use, speed and convenience of card payments have crowded out cash usage particularly in purchases of daily consumer goods. Only in 2009 did consumer card payments contract temporarily as a consequence of an abrupt decline in consumption caused by the financial crisis (Chart). The popularity of card payments primarily reflects technological advances, but the growth in card payments has also been boosted by impaired access to cash. The signing of card payment vouchers is already history, the rapidity of PIN authentication and retailer point-of-sale terminals has increased and the widespread use of contactless proximity payments is advancing at a brisk pace. At the same time, the number of cash dispensers has decreased. Mobile payment methods are likely to become general in Finland in the next few years as new services enter the market. Chart. Euro amounts of cash and card payments in Finland* EUR billion Figures for 2016 are advance estimates Estimated annual total of cash payments 2. Value of card payments, excl. retailer cards * The share of cash payments is based on an estimate made via distribution channels and household consumption, as comprehensive statistical data on all cash payments and cash recycling are not available. Sources: Federation of Finnish Financial Services and Bank of Finland. 1 It has always been important for payments to function as smoothly, efficiently and safely as possible. These principles have also been the point of departure for the new payment solutions. Banks new mobile payment devices enable easy execution of payments between individuals. Increasing migration of business into the online environment has created a need for safe identification, including biometric identification. In addition, providers of payment services have sought to lower unit costs for payments. Consumers and merchants have a need to monitor their use of money and payments via electronic ledgers and to conduct more thorough analyses thereof. Merchants also wish to enhance the efficiency of service provision. Shopping and payments are becoming increasingly personalised. A combination of services and payments opens up new opportunities for more efficient payment execution and provision of new services. New services also help reduce the need for cash. Items typically settled via cash payment will represent a declining proportion of households consumption expenditure as online shopping increases. An ever larger share of regular payments will be automated to take place in electronic systems. Besides services, a significant proportion of daily consumer goods trade could also move over to electronic order, delivery and payment systems. Another aim is that, in the near term, electronic payments could already be transferred between banks from one account to another within a few seconds. Moreover, a number of operators are currently working, among other things, on the application of blockchain technologies in new payment solutions. We can assume that, going forward, digitalisation will make increasingly powerful inroads into the payments sphere. 28 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

30 Financial asset management The Bank of Finland manages financial assets totalling EUR 19,082 million. These assets comprise the Bank of Finland s financial assets, the share of foreign reserve assets transferred to the European Central Bank and the Bank of Finland s pension fund assets. At the end of 2016, the total values of these assets amounted to EUR 17,382 million, EUR 1,087 million and EUR 613 million, respectively. Bank of Finland s financial assets and financial asset management The Bank of Finland s financial assets comprise foreign reserves, euro-denominated financial assets, gold and equities. The foreign reserves consist of the foreign currency-denominated fixed-income investment portfolio and items denominated in IMF Special Drawing Rights (SDRs) (Table 2). The Board of the Bank of Finland takes decisions on the amount of the Bank s financial assets in accordance with the Agreement on Net Financial Assets (ANFA) between the Eurosystem central banks. It sets rules and limits for such holdings of national central banks as are related to the discharge of their national tasks. The Board did not change the amount of financial assets in The Bank of Finland s net financial assets at the end of 2016 amounted to EUR 7.8 billion. These assets are calculated by deducting the liabilities not directly related to monetary policy on the liabilities side of the balance sheet from the assets not directly related to monetary policy on the assets side of the balance sheet. Objectives and yield from the management of financial assets The Bank of Finland invests its assets on the international financial markets (distribution of the financial assets by currency, see Table 3). The objective of financial asset management is to meet the liquidity, security and return requirements placed on the central bank in respect of the assets managed. In managing its financial assets, the Bank of Finland secures the value of Table 2. The Bank of Finland's financial assets 31 Dec Dec 2015 Gold 1,731 1,534 Foreign reserves 6,554 6,193 SDR Foreign currency-denominated fixed-income investment portfolio 6,022 5,812 Euro-denominated financial assets 8,807 9,023 Equity Total 17,382 16,883 The liquidity portfolio was still presented as a separate item in 2015, but here it is combined with the foreign currency-denominated fixed-income investment portfolio. Source: Bank of Finland. Table 3. Distribution of the Bank of Finland's financial assets by currency Currency 31 Dec Dec 2015 Euro (EUR) 9,097 9,156 US dollar (USD) 4,731 4,487 Pound sterling (GBP) Japanese yen (JPY) Gold (XAU) 1,731 1,534 SDR Total financial assets 17,382 16,883 Equity investments are included within the euro entry. Source: Bank of Finland. Table 4. Return* on the Bank of Finland's financial assets in 2016 and % % 2015 Interest rate return Currency revaluation Equity return Total * Excluding gold and SDR. Source: Bank of Finland. Bank of Finland activities 2016 Bank of Finland Annual Report

31 Table 5. Allocation of the Bank of Finland's fixed-income investment portfolios at the end of 2015 Fixed-income investment portfolios Allocation (%) Government debt instruments 55.6 Government-related debt instruments 21.3 Covered bonds 7.7 Corporate bonds 8.0 Cash holdings 7.4 Total 100 Source: Bank of Finland. these assets and its ability, when necessary, to support the liquidity of the banking system. The strict limits set for investment risk ensure prudent management of the Bank s financial assets. In 2016, the structure of the financial assets was simplified by combining the liquidity portfolio with the fixed-income investment portfolio. The liquidity of the financial assets is secured by minimum amounts of holdings of US and German government bonds, which ensure the Bank of Finland s ability to provide liquidity for acute policy needs under all circumstances. Equity holdings were increased in 2016 according to plan, in compliance with a prudent approach and within the limits permitted by the role of the central bank. The total return on the Bank of Finland s financial assets in 2016 was 1.02%, i.e. around EUR million. This return breaks down into interest rate and equity returns and valuation changes due to exchange rate movements (Table 4). The low level of interest rates is reflected in the interest rate return, which in 2016 was positive in the amount of EUR 68.8 million. Equity investments generated returns of EUR 28.9 million in 2016, on account of dividends and higher valuations. In 2016, valuation changes due to exchange rates were positive, at EUR 55.0 million. The appreciation of the US dollar (+3.3%) and the Japanese yen (+6.2%) covered valuation changes resulting from the depreciation of the pound sterling ( 14.3%). Fixed-income investment portfolios are subject to strategic allocation and duration. The Bank s Investment division is allowed to deviate from these by making active investment decisions within pre-set bounds for permitted leeway and strict risk limits. Portfolio returns are benchmarked against public indices that are customised for central bank needs. In 2016, the investments generated a return of 0.11%, i.e. EUR 14 million, above the benchmark indices. The excess return according to the three-year rolling average was 0.07%. Maturity of US dollar-denominated investments was extended The Bank of Finland s fixed-income investment portfolios are held in government and government-related securities, covered bonds, corporate bonds and cash (Table 5). The average maturity of these assets at the end of 2016 was 2½ years for investments in US dollars, 2 years for investments in pounds sterling, 1½ years for euro-denominated investments and 1 year for investments in Japanese yen. Compared with the previous year, the maturity remained the same, except for US dollar-denominated investments, whose maturity was extended by six months. ECB reserves managed together with Estonian central bank Management of the foreign reserves of the European Central Bank has been distributed among the Eurosystem national central banks according to their respective capital keys. The emphasis is on security and liquidity, as the key purpose of the reserves is to ensure the availability of sufficient resources for the Eurosystem s potential foreign exchange interventions. The Bank of Finland manages part of the ECB s reserves together with the Bank of Estonia. The value of Finland and Estonia s pooled US dollar-denominated portfolio of the ECB s foreign reserves was at the end of 2016 about EUR 1,087 million. The ECB s Annual Report provides additional information on the management of its foreign reserves. Management of Bank of Finland Pension Fund assets unchanged The objective of the Bank of Finland Pension Fund is to manage the assets held to cover the Bank s pension liabilities in accordance with the generally accepted 30 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

32 principles for the management of pension assets. These may deviate from the principles applied to the management of the central bank s financial assets. On 31 December 2016, the value of the pension fund s assets was EUR 613 million, with the Bank s pension liabilities amounting to EUR 564 million. The total return on assets in 2016 amounted to 3.3%. More information on the pension fund s asset management is available from the fund s own annual report. Investment risks and risk management In investing its own financial assets, the Bank of Finland is exposed to market risks, credit risks, liquidity risks and operational risks. Market risks include exchange rate risk, interest rate risk and risks arising from fluctuations in the price of gold and stock prices. More precise definitions of the risks, with additional information on risk management, can be found in the Notes on risk management (p ). Information on the total risk exposure on the Bank of Finland s balance sheet is provided on pages Foreign reserve portfolio exposes to exchange rate risk Exchange rate risk remained the most significant risk in the Bank of Finland s financial asset management in 2016, as in previous years. This is due to the Bank holding a foreign reserve portfolio for the purpose of discharging its central bank functions. The foreign reserves consist of claims on the IMF (Special Drawing Rights, SDRs) and investments denominated in US dollars, pounds sterling and Japanese yen. The Bank does not generally hedge foreign currency-denominated investments and claims against exchange rate risk. In previous years, hedging against SDR exchange rate risk was used, but this practice was abandoned in late The targeted size and currency composition of the foreign reserve portfolio is assessed by the Bank at three-year intervals. This assessment was undertaken in early Higher target duration for US dollardenominated fixed-income investments The Bank of Finland s own financial assets are mainly invested in fixed-income instruments, and the related interest rate risk is managed by spreading the investments among several debt instruments with differing maturities. In managing interest rate risks, the Bank primarily relies on modified duration (see Definitions and concepts, p. 92). The target durations of the Bank s fixed-income investment portfolios are normally decided for each currency once a year, and in 2016 a decision was made to raise moderately the target duration of US dollar-denominated fixed-income investments. The modified duration of all the Bank s fixed-income investments at the end of the year was approximately 1.8, compared with around 1.7 at the end of The daily level of interest rate risk is also measured by the Value-at-Risk (VaR, see Definitions and concepts, p. 92) method. Moreover, the VaR figure is used to limit the fixed-income investment portfolio interest rate risk relative to the benchmark index. Total market risk in the Bank s own financial assets declined slightly VaR figures are calculated daily for total market risk, exchange rate risk and equity risk as well as interest rate risk. The year-end amount of total market risk was at a slightly lower level than at the end of 2015 (Chart 10). Equity investments Chart 10. VaR figures for market risk in the Bank of Finland s financial assets in 2016* 4 5 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 1. Total market risk 2. Total market risk (excl. gold) 3. Exchange rate risk 4. Interest rate risk 5. Equity risk * One-day horizon, 99% confidence level. Source: Bank of Finland Bank of Finland activities 2016 Bank of Finland Annual Report

33 increased on the previous year. They are made as indirect investments via equity funds and are distributed across several markets and several companies, which reduces the risks related to equity holdings. No significant changes in credit, liquidity and operational risks and related risk management The total credit risk arising from investments is gauged and monitored in terms of a separate credit risk VaR method. Additionally, credit risk is managed by diversifying investments, within established limits, across several issuers and counterparties. Issuers of securities serving as investments and Bank of Finland counterparties are subject to criteria designed to ensure sufficient counterparty and issuer creditworthiness. The factors used in assessing creditworthiness include public credit ratings provided by rating agencies and market-based indicators. Liquidity risk is managed by restricting the size of holdings of individual issues or of total issuer debt. There are also restrictions in place for the length of maturities of some instruments and for securities lending and short selling. Although the separate concept of liquidity portfolio in the management of the Bank s own financial assets was abandoned in 2016, attention is still paid to the characteristics of investment instruments. A significant proportion of the assets is still held in investment instruments that are saleable within a short period of time and at low cost. Monitoring of operational risks covers, among other things, risks related to staff and information systems. These are managed by, for example, regularly tested and adequate backup arrangements and reliable and well-documented workflows and instructions. Photo: Peter Mickelsson. 32 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

34 Banknotes and coins The Bank of Finland is responsible for ensuring the availability of euro cash in Finland. In practice, the Bank does this by using the distribution systems of stakeholders in professional cash supply, such as ATM companies, banks, shops and cash-in-transit companies. As in many other euro area countries, the vast majority of euro banknotes is distributed to the public in Finland via the ATM network. The majority of cash returns to the central bank comes from retail shops collected, sorted and transported by cash-in-transit companies. The Bank of Finland checks the authenticity and fitness of euro banknotes returned from circulation, withdraws unfit banknotes from circulation and replaces them with new notes. The net issuance of banknotes by the Bank of Finland remained stronger than overall economic growth and private consumption in Finland (Chart 11). The growth rate of orders of EUR 50 banknotes exceeded that of other banknotes in 2015, and the trend continued in The issuance of cash appears to be increasingly affected by the use of cash when traveling abroad. Domestically, however, the use of cash as a payment method is slowly declining. According to an estimate calculated on the basis of Statistics Finland s financial accounts, almost half of cash issued in Finland is held outside the country (Chart 12). Availability of cash weakened further States or central banks have always issued banknotes and coins specifically to ease payment and further the transfer of economic purchasing power via cash savings. As a physical means of payment, cash can be used in retail trade mainly in face-to-face business transactions, automated payment machines, person-toperson payments and income transfers. As electronic payment devices advance and commerce moves more extensively online, the use of cash is declining. Cash usage is also declining because of its weaker availability via key distribution channels. In addition, the possibilities to use cash have recently decreased due to restrictions introduced in public payments such as, for example, parking meters, library fines, tax payments and public transport tickets. Automatia, which operates banks united ATM network, began an extensive replacement of Otto ATMs by TalletusOtto cash recycling machines (CRMs) in At that time Automatia cut the Chart 11. Banknote issuance and economic activity Log percentage Bank strike 1990 Changeover to euro banknotes Annual change in private consumption, % 2. Annual change in GDP, % 3. Annual change in issuance of banknotes, % Sources: Bank of Finland and Statistics Finland. Chart 12. Banknotes circulating in Finland and cash outflows abroad illion 16,000 14,000 12, ,000 8,000 6, ,000 2, , Cash issued in Finland held abroad 2. Total cash in Finnish economy Source: Statistics Finland Bank of Finland activities 2016 Bank of Finland Annual Report

35 number of ATMs by a net total of 117. In 2016, the ATM network was thinned further by 87 units. Automatia seeks to maintain the number of transactions at cash machines sufficiently high for efficiency and profitability reasons. In 2016, a total of 7,400 cash withdrawals were made per machine per month. During 2016 many deposit banks operating in Finland announced that they would begin to charge a fee for ATM cash withdrawals exceeding a certain number of withdrawals per month. The purpose behind the fee was not only to cover costs to banks from cash withdrawals but also to reduce the total number of cash withdrawals, since banks pay ATM operators withdrawal-specific charges on ATM cash withdrawals. Partly because of these fees, the average withdrawal value is already over EUR 105. Issuance of EUR 500 banknotes will end Several euro area countries have already limited the use of large cash amounts to hinder tax evasion-related sales that bypass bookkeeping. In international monetary policy debate, the existence of zero-interestrate cash has also been regarded as a barrier to negative monetary policy rates. In early 2016 the public debate on the alleged association of large euro banknotes Chart 13. Issuance of euro banknotes in euro area by denomination EUR billion EUR EUR EUR EUR EUR EUR EUR 5 Source: European Central Bank with the grey economy, drug business and terrorist financing reached such a point that the Governing Council of the ECB decided in May 2016 to stop producing the highest value banknote the EUR 500 note and to exclude it from the new banknote series. The Banknote Committee was mandated to make preparations for practical implementation of the decision. After introduction of the highest denominations of the new Europa series EUR 100 and EUR 200 banknotes, EUR 500 banknotes returning from circulation will be permanently withdrawn from circulation as they return to the central banks. At the same time, however, it was emphasized that central banks will continue to redeem EUR 500 banknotes indefinitely. The decision to end the issuance of the EUR 500 banknote at the end of 2018 was already reflected in banknotes in the euro area in the first half of 2016: returns of EUR 500 notes were commenced and central banks began to replace them with EUR 100, EUR 50 and EUR 200 notes (Chart 13). So far, the total volume of euro banknotes has not changed in value terms, even though at the end of 2015 the share of the EUR 500 note in the total value of euro banknotes had already declined to 24%. Replacement of EUR 20 banknotes continues At the end of November 2015, the third denomination in order of value in the Europa series the EUR 20 banknote was put into circulation. When the new EUR 5 and EUR 10 banknotes were introduced, it was detected that the actual amounts circulating in Finland were probably at most half the total amounts put into circulation by the Bank of Finland. This was surprising because these small denominations are not available in ATMs and are largely used as change money similar to coins. For this reason, it has not been assumed that much of these banknotes migrate in wallets to other euro area countries. The stocks of the smallest EUR 5 and EUR 10 banknotes of the old series have practically already been exhausted, and return of the old series to the Bank of Finland has slowed to a trickle. Issuance of the new EUR 20 banknotes was brisk in the first months of 2016, so that the users would become familiar with 34 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

36 them. In later months, issuance of the old series increased again, to exhaust the stocks. Therefore, the overall replacement of the EUR 20 banknote has so far been rather slow. It picked up already towards the end of 2016, however, with the depletion of the Bank of Finland s stocks of the old series (Chart 14). Renewal of banknote sorting machines The Bank of Finland is responsible for ensuring the fitness of banknotes in circulation. In the sorting process at the central bank, banknotes go through an automated authenticity and fitness inspection. Banknote fitness checking covers checking banknotes for e.g. dirt, tear, folds, graffiti and wear. Fit banknotes are put back into circulation and unfit notes are destroyed. In January 2016, The Board of the Bank of Finland decided to launch a tender procedure for the procurement of new banknote sorting machines. The new sorting machines will replace the old De La Rue CPS 1800 machines, which were already approaching the end of their service life. The technology of the old machines was also becoming outdated. The tender was won by the German Giesecke & Devrient, which is currently a market leader in banknote sorting machines used by central banks in Europe. Procurement and maintenance contracts for two BPS M7 machines were signed in September 2016, and the machines will be in use from the beginning of April These sorting machines can process as many as 33 banknotes per second. Increase in number of counterfeit banknotes Distribution of counterfeit banknotes has previously been more common in Finland during the summer months. It has, for instance, been easier for foreign distributors to distribute counterfeits at large summer events where people use a lot of cash. In early 2016, the EUR 10 of the new banknote series was the most distributed counterfeit in Finland, while in late spring the new EUR 50 banknote was the most common counterfeit found in circulation. Contrary to the norm, the number of counterfeits found in circulation declined this time in June July, but increased again towards the end of the year (Chart 15). Chart 14. Replacement of EUR 20 banknote by new series in Finland 1,000 notes 160, , , ,000 November ,000 60,000 40,000 20, Issuance of EUR 20 of the old series 2. Issuance of EUR 20 of the new series 3. Issuance of EUR 20, total 4. Returns of EUR 20 of the old series Source: Bank of Finland. Chart 15. Counterfeit euro banknotes in Finland by denomination, Notes/month In Dec 2016, total 1,055 notes EUR 5 2. EUR EUR EUR EUR EUR EUR 500 Source: National Bureau of Investigation. The number of counterfeit banknotes continued to grow on the previous year. In the end, over 2,171 counterfeits were found in Finland, which is a record number in the entire history of euro banknotes in Finland. About half of this was explained by a single case of EUR 500 counterfeit notes found in a private payment transaction in December Compared with other euro area countries, however, the number of counterfeits found in circulation in Finland is among the lowest Bank of Finland Annual Report

37 Other operations Research Economic research at the Bank of Finland supports the Bank s policy preparation, operational development and external influence. The aim of the Research unit is to produce internationally top-ranking research in areas of key importance to the Bank s activities. This allows the Bank to make a strong contribution to debate on monetary policy and financial market developments, both in Finland and internationally. The role of the Research unit in the Bank s policy development remained substantial in Policy-related activities, including activities in Eurosystem working groups, supported the Bank s efforts to increase the profile of its research economists as public intellectuals. Impacts of demographic change and immigration a key research theme Important economic research themes and topics that kept the international research community busy in 2016 were the macroeconomic impacts of demographic change and massive immigration (including their consequences for fiscal sustainability), the impact of the prolonged period of low interest rates on expected inflation and inflation outcomes and asset prices, as well as future monetary policy challenges and new policy regimes. Issues concerning the unequal distribution of income and wealth are now a key topic of macroeconomic research. Statistics show clearly that over the past 30 years or so, and particularly in the higher income bracket, income inequality has increased markedly in some countries, such as the United States. Finland, too, has experienced an increase in inequalities in income and wealth. There are, however, differences across countries. In France and Japan, income inequality has increased only slightly. The international research community is interested particularly in the factors that could explain the differences between countries. Entrepreneurship appears to be a significant, perhaps even key factor. European Summer Symposium in International Macroeconomics for the first time in Finland In 2016, the Bank of Finland co-organised several international scientific meetings on themes touching on its research activities. In May, the Bank hosted the four-day meeting European Summer Symposium in International Macroeconomics, which is a brand of the Centre for Economic Policy Research, based in London. The meeting is arranged every other year in Tarragona, Spain, and every other year outside Spain. This meeting is a high-level symposium with a very high international profile. In June, the Bank of Finland hosted a one-day conference in Helsinki entitled Going Cashless, in which the participants engaged in a lively debate on alternative ways to remove the lower bound on nominal interest rates. One of the options was to abolish paper currency. In August, the Bank participated for the sixth time in the annual international seminar on Risk, Financial Stability and Banking, held in São Paulo, Brazil. The seminar was hosted by Banco Central do Brasil. The best research inputs presented at the seminar will be published in the forthcoming special issue of the Journal of Financial Stability. Bank of Finland Institute for Economies in Transition The research efforts of the Bank of Finland Institute for Economies in Transition (BOFIT) concentrate mainly on applied research with a focus on monetary and exchange rate policy issues and the functioning of financial systems. The primary countries of focus are Russia and China, although individual research topics often require the use of more extensive comparative data. Collaboration between research, monitoring and forecasting forms the foundation for the work of BOFIT s experts. The year 2016 marked the 25th Anniversary of the establishment of BOFIT. In 2016, BOFIT continued to publish (in both Finnish and English) its popular weekly digest of economic news items from Russia and China. These go out to around 1,800 subscribers all over the world. Another aspect of BOFIT s work was the 36 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

38 Box 5. Financial cycle explains long-term effects of monetary policy In 2016, over 30 studies were published in the Bank of Finland Discussion Paper series. Projects focusing on macroprudential analysis studied e.g. economic agents expectations, stagnation and fiscal policy, monetary policy and the financial cycle in an environment of exceptionally low interest rates, as well as the interaction of monetary policy and macroprudential policies in economic stabilisation. Results show that when expectations are sufficiently pessimistic, it can sink the economy into steady-state stagnation with deflation. The most recent estimates based on alternative methods show that the natural interest rate in the United States is higher than earlier estimates would suggest. Results suggests that monetary policy, through the financial cycle, has a long-lasting impact on output and, by implication, on real interest rates. Using monetary policy alone is, however, not enough to fully stabilise the economy if the effectiveness of the financial market is weakened due to a friction caused by an incentive problem. In such a case, a separate macroprudential tool could be useful, particularly if the disturbances arise from the financial sector itself. Macroprudential analysis was also deployed to examine how informative is the ECB survey on inflation expectations, the public funding of banks and non-financial firms in times of crisis and the link between population age-structure and inflation. The results show that because of heterogeneity across individual views, aggregated inflation expectations in the ECB Survey of Professional Forecasters must be analysed also on a micro level. The credit market can be particularly vulnerable to factors that affect bank capital if bank capital is scarcer than corporate capital. In such a case, government funding may have positive buffer effects if the government covers some of the possible loan losses. Public funding may have negative effects on bankers and entrepreneurs incentives. Empirical analysis also shows that there is a surprising link between long-term inflation and the population age structure: both young and old age groups are inflationary. Other research projects at the Bank of Finland examined statistical methods used in predicting financial crises, a shadow rate model with a time-varying lower bound of interest rates, as well as switching costs and financial stability. Unit root methods have long been used in the detection of financial bubbles in asset prices. New results show that early warning signals identified in multiple time series can be combined into a composite indicator, in which case time series with a higher frequency of observations can be used for providing timely warning signals. In turn, the shadow rate model with a time-varying lower bound outperforms the constant lower bound model in euro area data. Research suggests that the time-variation in the lower bound is related to the euro area deposit facility rate and, thus, to monetary policy. New research shows that the effect of intensified deposit market competition on the probability of bank failures depends critically on whether the focus is on bank competition for established customer relationships or competition for the formation of such relationships. The former destabilises, while the latter stabilises the banking market. Bank of Finland activities 2016 Bank of Finland Annual Report

39 seminars on the Russian and Chinese economies. These seminars (presented in Finnish) are very popular, and the online presentations in particular attract a large following. BOFIT research is published initially in the Institute s own Discussion Papers series and later in refereed scientific journals. In 2016, a total of 20 Discussion Papers were published. In addition, 11 shorter reports were published in the BOFIT Policy Brief series. As well as the articles of the in-house researchers, the Discussion Papers series also includes articles by visiting scholars and studies presented at BOFIT s seminars and workshops. A total of 28 visiting scholars from 12 countries worked with BOFIT in In connection with the Bank of Finland s March and September forecasts for the international economy, BOFIT published forecasts for the economic outlook for Russia and China in the immediate years ahead. The persistent difficulties in the Russian economy and the various spill-over effects of slowing economic growth in China have increased the demand for BOFIT analyses both in Finland and abroad. The number of presentations given to various types of audiences as well as media interest in developments in Russia and China have remained considerable. In November, the BOFIT 25th Anniversary Conference was held at Finlandia Hall. The conference brought together a large number of participants interested in the economies of Russia, China and other countries. The keynote speeches were delivered by Justin Yifu Lin (Peking University, former World Bank Chief Economist) and Gérard Roland (University of California, Berkeley). Professor Lin was quite optimistic about China s future growth, as long as economic policy remains targeted at growth. Professor Roland, in turn, examined the transition in economies in Central and Eastern Europe in the past 25 years and its implications for economics and economic policy. In September, BOFIT organised its third conference on the Chinese economy. The conference was co-organised by the City University of Hong Kong and focused on the interaction between the Chinese financial system and the global economy. The ongoing opening up of the Chinese economy will further increase the impact of the Chinese financial markets on the global economy. The keynote speeches were delivered by Kjetil Storesletten (University of Oslo) and Michael Melvin (University of California, Santa Cruz). In October, BOFIT organised a workshop in Moscow in cooperation with the Higher School of Economics. The workshop was entitled Banking in Emerging Markets: Challenges and Opportunities. Statistics The Bank of Finland is responsible for producing the Finnish data for euro area financial statistics for the European Central Bank. Statutory ESCB statistics and statistics required by international organisations were produced in 2016 as required and disseminated according to schedule. The Eurosystem s largest statistics project in the immediate years ahead is the establishment of a common granular analytical credit database. The project was launched at the Bank of Finland in The project involves the construction of systems for the collection and processing of data from a national credit database. The systems must be ready and operational in In the first stage, the new analytical credit database will include credit granted by credit institutions to non-financial corporations and other legal entities. In future, the database may be expanded to also cover information that serves supervisory needs, as well as household credit, and credit granted by corporations other than credit institutions engaged in lending. In national implementation, regular cooperation with the financial sector has from the start played an important role, and all interested credit institutions have been invited to join the working group also saw the launch of two new ESCB statistical reporting processes: one covers the balance sheet items of insurance corporations and the other transactions conducted by banks on the money markets. The first reporting of quarterly data to the ECB on insurance corporations was in summer The data are collected in connection with the Solvency II reporting of the insurance sector, and this reporting also serves the needs of the financial accounts 38 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

40 Box 6. Granular credit database supports decision-making The Governing Council of the European Central Bank adopted in May 2016 Regulation (ECB/2016/13) on the establishment of a new, euro area-wide harmonised granular credit database. As a result of the Regulation, euro area Member States will start collecting, as of September 2018, granular credit and credit risk data, using harmonised definitions and data content. The new database will include data on credit granted by credit institutions to legal entities (non-natural persons), the related protection as well as the parties to the loans or protections. The database will include approximately one hundred data attributes. Previously, euro area national central banks have collected only securities-related data on the level of single contracts, whereas data on other balance sheet items has been collected on a more general level. The credit database that is now being established can be considered as the start of a new era as Member States collect data based on common principles and in greater detail. Supports decision-making and analysis Many European Union Member States have a long tradition in utilising credit registers often operated by the national central bank. However, the data content of these registers varies considerably from one country to another, and therefore the data collected in the individual countries are not particularly comparable. In contrast, Nordic national central banks (for example) have not operated any credit or borrower-specific registers or databases. The new credit database for the euro area will create a dataset based on common principles and a common starting point, and that can be utilised in euro area decision-making, together with statistics already being collected. The granular credit database will be usable in, for example, the monitoring of cross-border risks, analysis of monetary policy operations, risk management, financial stability surveillance and macroprudential policy and research. The data will also be utilisable in banking supervision. A concrete example of the possibilities provided is the analysis of lending to and the indebtedness of small and medium-sized enterprises (SMEs), because external financing of euro area SMEs is based largely on bank lending. SMEs significance for the euro area banking system is considerable, and the possibility of a more detailed analysis will therefore support euro area decisionmaking. Following the recent financial crisis, the amount of non-performing loans increased strongly in some euro area countries. The harmonised credit database will enable a more efficient monitoring of non-performing loans and provide better tools for analysing the reasons. The more detailed analysis will support euro area decision-making, with the aim of preventing the creation of similar chains of events. Credit database at the Bank of Finland In 2010, the Bank of Finland combined, into a single data collection, the ECB s reporting requirements for e.g. credit institutions concerning balance-sheet, interestrate and security-by-security data, as well as the data requirements of the Bank for International Settlements. Credit institutions report to the Bank of Finland data on their debts and receivables only once, after which the Bank generates the various data for different authorities based on their requirements. The reporting of various data within a single data collection ensures the consistency of statistical data. The increasingly detailed reporting requirements for credit-specific data requires from central banks a capacity to reform their operations. With the establishment of the analytical credit database, the Bank of Finland s statistics unit is facing its largest IT project ever. In this credit data project (LuoTi) which has already started, the Bank of Finland is creating a system for processing increasingly granular data. In the first stage, the system will include granular credit data. In future, the objective of the statistics unit is to incorporate the current data requirements into a new system entity that would minimise the reporting burden on credit institutions, despite the increasing data requirements. Bank of Finland activities 2016 Bank of Finland Annual Report

41 prepared by Statistics Finland. Daily money market statistical reporting was launched on 1 July The statistics cover unsecured and secured financial transactions and some derivatives transactions concluded on the euro money markets. In 2016, the Bank of Finland also prepared for the extension of ESCB statistical reporting on supplementary pension funds in the insurance sector. In the area of securities statistics, work continued on harmonising data on issuance statistics in line with the ECB s Centralised Securities Database (CSDB). In addition, the Bank of Finland, in cooperation with Statistics Finland and the State Treasury, made preparations for Finland to join the IMF s SDDS Plus initiative. The SDDS Plus is the IMF s extended standard for the dissemination of economic and financial statistics, including several new data categories. The countries that have joined the initiative are committed to disseminating these statistics with the prescribed periodicity and timeliness. Finland will join SDDS Plus in early International activities The Bank of Finland participates in the work and decision-making of the European System of Central Banks (ESCB). It also has a statutory responsibility for Finland s contacts with the International Monetary Fund (IMF) and is a shareholder of the Bank for International Settlements (BIS). In addition, the Bank of Finland operates diversely in many Nordic, European and other international fora. The European System of Central Banks (ESCB) The Eurosystem s highest decision-making body is the Governing Council of the European Central Bank (ECB), which comprises the six members of the Executive Board of the ECB and the governors of the national central banks of the 19 euro area countries. The Governor of the Bank of Finland, Erkki Liikanen is a member of the ECB s Governing Council. Deputy Governor Pentti Hakkarainen was the Governor s personal alternate on the Governing Council. Governor Liikanen is also a member of the ECB s General Council, which includes the President and Vice-President of the ECB and the governors of all the national central banks of the 28 EU Member States. The Governing Council of the ECB convenes in Frankfurt twice a month on average. It holds monetary policy meetings every six weeks. In other meetings, the focus is on other tasks and responsibilities of the ECB and the Eurosystem. The Governing Council also makes the banking supervision decisions concerning significant credit institutions in the euro area. In 2016, the Governing Council held one meeting outside Frankfurt. This was held in the Austrian capital, Vienna. The Governing Council also held teleconferences and made decisions using a written decision-making procedure. Board members and experts from the Bank of Finland participated in the work of the ESCB at all stages of preparation. The Bank of Finland had at least one representative on each of the committees and was represented in most of the working groups operating under the various committees. Governor Liikanen was Chairman of the ECB s Audit Committee, whose task is to improve ECB and Eurosystem governance and control. Deputy Governor Hakkarainen was the Chairman of the Budget Committee. He also chaired the ad-hoc Forum on Supervisory Fees, which examined the costs and fees of banking supervision. In 2016, a total of 17 Bank of Finland employees were seconded to the ECB on fixed-term contracts of varying length. The ECB s Governing Council and the Supervisory Board, which prepares supervisory decisions on euro area banks, held four joint meetings in 2016, where they discussed macroprudential issues. International Monetary Fund The Governor of the Bank of Finland, Erkki Liikanen is Finland s representative on the highest governing body of the International Monetary Fund (IMF), the Board of Governors. His alternate member was Deputy Governor Pentti Hakkarainen. In October 2016, the Board of Governors held its Annual Meetings in Washington, DC. The IMF s advisory International Monetary and Financial Committee (IMFC) met in April and October in Washington, 40 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

42 DC. Both meetings discussed the outlook for the global economy and challenges for economic policy as well as issues relating to financial stability. The discussions gave support to economic policies that strengthen growth and stressed the importance of structural reforms. Changes in the structure of China s economic growth and its implications for global economic developments were discussed on several occasions. It was also emphasized that the IMF s resources should be maintained at their current level. The IMF has 189 member countries, which are represented on an Executive Board consisting of 24 Directors. Christine Lagarde, Chair of the Executive Board, is the IMF s Managing Director, and in 2016 she was appointed for a second five-year term. The Nordic-Baltic constituency has a common representative on the Executive Board. In 2016, coordination of economic policy views within the constituency was led by Sweden, with participation from the Bank of Finland and Finland s Ministry of Finance. The Nordic-Baltic Monetary and Financial Committee (NBMFC) convened in Denmark and Sweden before the spring and autumn IMFC meetings in order to prepare the constituency s policy positions. The Bank of Finland was represented on the NBMFC by Deputy Governor Pentti Hakkarainen. The IMF s quota and governance reform, which was approved in 2010, became effective in January The governance reform improved the adequacy of the IMF s base funding and increased the voting power of emerging economies and developing countries on the Executive Board. In October 2016, the Chinese yuan was included in the SDR (Special Drawing Rights) basket. Bank for International Settlements The Governor of the Bank of Finland took part in the regular Governors Meetings of the Bank for International Settlements (BIS). Discussions covered topical issues on the global economy and financial markets, such as market liquidity, macroprudential policy and challenges relating to growth and the improvement of the resilience of economies. Other important topics were cybersecurity and the effects of climate change on financial stability. The Bank of Finland was also represented at the Annual General Meeting of the BIS in June and the Extraordinary General Meeting in November. Nordic cooperation The Nordic central banks cooperated closely throughout Central Bank Governors met in Denmark at a meeting of the governors of the Nordic central banks and discussed e.g. monetary policy in the environment of low interest rates, housing markets, supply of cash and coins and the change in Nordea s organisational structure which enters into force in In addition to Board members, experts from the Bank of Finland s various functions also met in the course of the year with experts of other Nordic central banks. One of the key projects concerned crisis management of significant cross-border banks. The Nordic and Baltic central banks and supervisors held the biannual Nordic- Baltic Macroprudential Forum in Stockholm in April and November. The fora discussed issues relating to financial and macroprudential stability. Cooperation within the European Union The European Systemic Risk Board (ESRB) is part of the European System of Financial Supervision (ESFS). The ESRB is responsible for macroprudential oversight of the financial system and financial markets. The decisions of the ESRB are taken by the General Board. Governor Liikanen is a member of the General Board with voting rights. The key responsibility of the European Union s Economic and Financial Committee (EFC) is to prepare meetings of the ECOFIN Council of economic and finance ministers of EU Member States. In 2016, the Bank of Finland was represented on the EFC by Deputy Governor Pentti Hakkarainen. He participated in the meetings when the Committee convened in its extended composition and in the role of the Financial Stability Table. The Bank of Finland also participates in cooperation via the EU s Economic Policy Committee (EPC), which prepares the EU s economic policy guidelines and structural policy issues. Statistical issues are discussed in the Committee on Monetary, Financial and Balance of Payments Statistics (CMFB) Bank of Finland activities 2016 Bank of Finland Annual Report

43 and the European Statistical Forum. The Bank of Finland is also involved in the work of the Organisation for Economic Cooperation and Development (OECD) and is represented on the Board of Supervisors of the European Banking Authority (EBA). Other international cooperation The Bank of Finland continued its training cooperation with the Bank of Russia in 2016, including two training sessions at the Bank of Finland. Communications The Communications unit supports the attainment of the Bank of Finland s vision and provides the Bank s key target groups with information on monetary policy, financial stability, banking operations and currency supply. Using effective and specifically targeted communication, the Bank aims to keep the Finnish public well informed of the activities of the central bank. In 2016, the leading topics of the Bank of Finland s communications were the ECB s expanded asset purchase programme, the Bank of Finland s role in its implementation, and analysis of the effects of the purchases. The Bank also informed the public on the use of the new macroprudential tools. Furthermore, as part of transparency in communications, the Bank began to publish the Governor s monthly calendar on its website. The Bank of Finland s publication website Eurojatalous.fi established its position and attracted around 86,100 visits and almost 58,700 visitors in Besides articles of the periodical Euro & Talous (and its English version, the Bank of Finland Bulletin), 51 blog articles and 25 analysis articles were published on the site. The effectiveness of communications was strengthened by encouraging Bank of Finland experts to communicate more actively on social media. The Communications unit provided training and support to the Bank s social media influencers. An increasing number of the Bank s employees now have a social media presence in their employment role. The Bank of Finland also served the general public via our telephone hotline and . The most common questions concerned interest rates, exchange rates, statistics and banknotes. In 2016, around 1,200 calls were made to the Bank of Finland s telephone hotline. The Communication unit s largest project in 2016 was the renewal of the Bank of Finland website Suomenpankki.fi. The renewed website was launched at the end of January The website renewal put particular emphasis on four aspects: 1. The website is responsive, meaning it functions smoothly irrespective of the user s device. 2. The website serves the user as well as possible in terms of its structure and content. 3. The website is more flexible to maintain and develop. 4. The website layout is modern and in line with the Bank s current visual image. The popularity of the Bank s visitor centre the Bank of Finland Museum remained as high as in the previous year. The Museum attracted almost 14,000 visitors and hosted 20 public events during the year. In addition to lectures for the general public, presentations of the Bank s economic forecasts and history seminars, the Museum introduced new economic policy-related discussion events which were hosted by Antti Suvanto, Adviser to the Board of the Bank of Finland. The Museum also organised a public event at which Markus Brunnemeier, Edwards S. Sanford Professor of Economics at Princeton University, presented his book The Euro and the Battle of Ideas. On 10 April, the Bank of Finland Museum opened an exhibition on the Great Depression. The Museum also hosted in April the final for the Generation uro Students Award competition for teams of secondary school students. This was won by the team from the upper secondary Etelä- Tapiolan lukio in Espoo. The Bank of Finland prepared for Finland s centenary year 2017 well in advance. The Bank made preparations for hosting a four-day open doors event Property of the Nation in the main office building. The event included an art exhibition, musical performances, speeches and a website-based art gallery ( 42 Bank of Finland Annual Report 2016 Bank of Finland activities 2016

44 Box 7. Bank of Finland representatives at the ECB, EU and other international bodies in 2016 Bank of Finland representatives on the Governing Council of the ECB Erkki Liikanen, member Pentti Hakkarainen, alternate Tuomas Välimäki, accompanying person Mika Pösö, accompanying person Katja Taipalus, accompanying person Bank of Finland representatives on ESCB committees International Relations Committee Olli-Pekka Lehmussaari Kristiina Karjanlahti (until 3 Nov 2016) Henna Karhapää (from 14 Nov 2016) Accounting and Monetary Income Committee Anne Forsback (until 1 Sept 2016) Sara Lähteenkorva (from 1 Sept 2016) Legal Committee Maritta Nieminen Eija Brusila Market Infrastructure and Payment Committee Kirsi Ripatti Heli Snellman Market Operations Committee Harri Lahdenperä Marjaana Hohti Organisational Development Committee Mika Pösö Jarno Talvitie Monetary Policy Committee Tuomas Välimäki Jarmo Kontulainen Samu Kurri Financial Stability Committee Katja Taipalus Risk Management Committee Antti Nurminen Jorma Jokisalo Banknote Committee Päivi Heikkinen Kari Takala Internal Auditors Committee Pertti Ukkonen Helena Rantanen Information Technology Committee Petteri Vuolasto Statistics Committee Laura Vajanne (Until 1 Nov 2016) Harri Kuussaari Committee on Controlling Tuula Colliander Marko Ala-Pöntiö External Communications Committee Jenni Hellström Richard Brander (from 27 Apr 2016) Budget Committee Pentti Hakkarainen, chair Veli-Matti Lumiala Human Resources Conference Antti Vuorinen Eija Lepola Bank of Finland representatives on EU committees and the Supervisory Board of the Single Supervisory Mechanism General Board of the European Systemic Risk Board (ESRB) Erkki Liikanen Economic and Financial Committee Pentti Hakkarainen Mika Pösö, deputy member Supervisory Board of the Single Supervisory Mechanism (SSM) Jouni Timonen Advisory Technical Committee of the ESRB Katja Taipalus Economic Policy Committee Lauri Kajanoja European Banking Authority's Board of Supervisors Jouni Timonen Committee on Monetary, Financial and Balance of Payments Statistics Laura Vajanne (until 1 Nov 2016) Harri Kuussaari (from 1 Nov 2016) European Statistical Forum Laura Vajanne (until 1 Nov 2016) Harri Kuussaari (from 1 Nov 2016) Bank of Finland representatives at the Bank for International Settlements (BIS), the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD) BIS meetings of central bank governors Erkki Liikanen IMF Board of Governors Erkki Liikanen Pentti Hakkarainen, alternate OECD Economic Policy Committee Ilkka Korhonen Samu Kurri OECD Financial Markets Committee Jyrki Haajanen Bank of Finland activities 2016 Bank of Finland Annual Report

45 Management and personnel Strategy The Bank of Finland seeks to ensure that the Bank is known as a forward-looking and effective central bank and as a constructive and influential member of the Eurosystem. The main themes of the Bank s strategy work in 2016 were focused on measures aimed at 1) increasing the effectiveness of activities relating to monetary policy and financial stability, 2) exploiting digitalisation and foreseeing its effects, and 3) updating the Bank s operational practices and procedures. The Bank continued to commit resources to the development of monetary policy models and instruments and participated in the relevant economic debate. In addition, assessments were made of the impact of alternative economic scenarios and inflation paths on the euro area and Finnish economies and on the balance sheet of the Bank of Finland. The Bank was involved in conducting the ECB s monetary policy and implementing the asset purchase programmes. The purchase programmes increased the size of the Bank of Finland balance sheet. The importance of anticipating, monitoring and reporting risks that could threaten the Bank s capital adequacy was further highlighted. Financial stability analysis and macroprudential policy have become increasingly important aspects of central bank activity in recent years. Digitalisation and globalisa- tion exert an influence on banks and the financial sector, reshaping financial system structures and business models. In the work of securing the stability of the financial system, smooth Nordic cooperation has also come to play an even more pronounced role. The Bank of Finland clarified the processes and communications related to its work in the field of financial stability. Digitalisation is strongly modifying the operating environments of all the Bank of Finland s core functions. One of the most fundamental key areas of change is the evolution of payment methods. As a monetary authority, the Bank of Finland participates in ensuring the availability of cash in Finland and oversees the reliability and efficiency of the Finnish payment system as a whole. The Bank closely monitors the development of cash usage and payment methods. In line with the Bank of Finland strategy, the Bank s influence is based on expertise, reliability and high-quality research. Coaching leadership methods are deployed to encourage staff members to pursue vigilance and readiness for problemsolving, to update their working practices and procedures, and to ensure that their skills are at the forefront. One example of the updating of working practices and procedures is that, in 2016, Bank of Finland employees increasingly participated in their professional capacity in social media communication, thereby contributing to public discussion of topical matters. 44 Bank of Finland Annual Report 2016 Management and personnel

46 Box 8. Bank of Finland's mission, vision, strategy and values Mission The Bank of Finland works towards economic stability. Price stability, secure payment systems and reliable financial systems are prerequisites for sustainable growth, employment and the wellbeing of Finnish society. Vision The Bank of Finland is known as a forward-looking and effective central bank and as a constructive and influential member of the Eurosystem. The vision underlines the Bank of Finland's objective of being a forwardlooking authority, whose activities and statements are constructive in promoting the long-term robustness and stability of the Finnish economy. The Bank itself aims to operate in the spirit of its own statements fostering effectiveness. A constructive role within the Eurosystem requires the Bank of Finland to be actively involved in developing solutions to common problems, while being influential imposes high expectations on the competence and communication skills of the Bank's personnel. Summary of the strategy The Bank of Finland's influence is based on expertise, reliability and research. We ensure the availability of competitive central bank services in Finland. We participate in maintaining the service level of the financial markets and related infrastructure. We maintain such capital adequacy and liquidity as is required by our operations, and we honour our financial accountability to Finnish society. Our working processes are of high quality, technically advanced and environmentally sustainable. We build our expertise and professional competitiveness with an eye to the future, while simultaneously caring for the long-term wellbeing of our staff. Values Competence Appreciation Responsibility The values reflect our attitude towards our own work, our colleagues and the rest of the society. Common values drive the staff's day-to-day activities and underpin the organisation's working culture. The entire organisation was involved in defining the Bank's values. Competence Appreciation Responsibility Our work builds on excellence and professional ethics. We keep our knowledge and skills at the forefront. We strive towards common objectives with mutual respect. We encourage open discussion and fresh ideas. We act responsibly and we are independent. We are a reliable and cooperative partner. Management and personnel Bank of Finland Annual Report

47 Box 9. Bank of Finland objectives and results framework I Influence and service capacity II Efficient use of resources and capital adequacy Strategic guideline Indicator Objective Situation 1. The Bank of Finland's influence is built on high-level expertise and research that combines both macroeconomic and financial market perspectives. 2. The Bank of Finland participates in preserving the service level of the financial markets and related infrastructure and offers competitive central bank services to its customers 3. Public confidence in the Bank of Finland and awareness of the Bank's and the Eurosystem's activities are promoted through effective, well-targeted communication. 4. The Bank of Finland's financial assets are invested in a secure and productive manner in accordance with international commitments and crisis management requirements. 5. The aim is to enable stable profit distribution to the State without jeopardising the Bank's capital adequacy. 6. The Bank of Finland is one of the most efficient central banks in the EU. ECB Governing Council members' evaluation of the Bank of Finland's influence Quality-weighted publication index for research Quality of central bank services from service users' perspective Consumer satisfaction survey on the quality and availability of cash Results of the Omnibus survey carried out by the market research company Taloustutkimus Visits (clicks) on the Bank's website Proportion of highly safe and liquid investments of financial assets Return on financial assets exceeding the central bank rate on investment currencies Reserve fund + provisions relative to balance sheet risks Distributed earnings Total annual full-timeequivalent jobs Total departmental operating expenses > 4 New indicator 12/ / / > > 95% of respondents satisfied 98% 94% 95% > Upper quartile of the benchmark group 3/12 3/12 3/12 Rising trend 1.8 million 2.2 million 1.9 million High High High High > 0; 5-year moving average Provisions are increased with the aim of ensring a sufficiently strong balance sheet under all circumstances. Stable profit distribution 2014: 402 annual full-time equivalent 2015: 383 annual full-time equivalent 2016: 400 annual full-time equivalent* Budget, 2014: EUR 57 million 2015: EUR 56 million 2016: EUR 56 million 1.5% 1.15% 0.80% EUR 5,208 million EUR 137,5 million EUR 5,375 million EUR 98,0 million EUR 5,576 million EUR 91.0 million * EUR 52.8 million EUR 52.1 million EUR 53.5 million * Incl. temporary staff. 46 Bank of Finland Annual Report 2016 Management and personnel

48 III Efficiency of internal processes IV Building the future Strategic guideline Indicator Objective Situation 7. The quality of the Bank of Finland's analytic and operational processes is actively enhanced. 8. The Bank of Finland's ICT solutions enable top-quality, influential work by our experts. 9. The activities of the Bank of Finland are environmentally sustainable 10. The Bank of Finland raises the expertise and professional competence of its staff. 11. The Bank of Finland cares for the long-term wellbeing of its staff. Fulfilled criteria as set out in department-specific agreements on objectives and outcomes Feedback on IT equipment and services Number of serious disruptions IT innovations that have increased productivity from the departments' perspective, survey result Total emissions / operating expenses (energy use) Waste kg / operating expenses Annual implementation of personal development plans 12/ / / % 75% 78% 79% 93% satisfied 88% 93% 92% Objective > 3, Falling trend Falling trend Over 80% of plans turn out well 71.5 kg CO 2 emissions/ energy use Volume of waste 2.03 kg / EUR 1,000 operating costs 67.5 kg CO 2 emissions/ energy use Volume of waste 2.25 kg / EUR 1,000 operating costs 89% 90% 92% Education level index > Proportion of the minority gender relative to the total number of supervisory staff Rising trend 33% 30% 30% 64.0 kg CO 2 - emissions/ energy use Sick leave absences Below 3.5% 2.9% 3.0% 2.5% Employee satisfaction index exceeds external benchmark group result Leadership index exceeds external benchmark group result > > Management and personnel Bank of Finland Annual Report

49 Management system The Bank of Finland s mission, vision, strategy and values (Box 8, page 45) provide a guide for the Bank s activities. The pillars of the management system are the division of responsibilities between Board members and the definitions of the areas of responsibility for each department and core process. Other key corporate governance tools include the objectives and results framework, action planning, staffing and budgetary ceilings and the overall assessment of risks, as well as performance evaluations and performance appraisal discussions. Key posts within the Bank of Finland, and particularly those exercising management responsibilities, are filled on a fixed-term basis. The purpose of this is to ensure broad-based competence and the updating of staff practices and procedures. Division of responsibilities between Board members In 2016, the division of responsibilities at the Board was as follows: Governor Erkki Liikanen was responsible for monetary policy preparation, domestic economic policy and financial market issues as well as external communications. He was a member of the Governing Council and General Council of the ECB and of the European Systemic Risk Board. Deputy Governor Pentti Hakkarainen bore responsibility for monetary policy implementation, investment activities, administration, legal and international affairs and macroprudential policy. He was also Chairman of the Board of the Financial Supervisory Authority. Member of the Board Seppo Honkapohja was responsible for scientific research, currency supply, market operations and payments, personnel and risk control for investment activities and monetary policy. Departments and core processes The Bank of Finland s activities are organised across six departments and the Internal Audit unit, which is independent of the departments. The heads of department report to the Board member responsible for the respective area. The Bank of Finland s core processes are monetary policy preparation monetary policy implementation influence on domestic economic policy financial stability policy. Process management helps emphasise a working culture based on cooperation and fosters a customer-oriented approach to operations, operational efficiency and effectiveness. Objectives and results framework The objectives and results framework is one of the tools for implementing the strategy. Each strategic guideline of the Bank of Finland is assigned at least one measurable objective. In addition to general indicators, each department and core process is provided with indicators to guide their activities (Bank of Finland objectives and results framework for , p. 46). Achievement of the objectives is evaluated every six months. Action planning Action planning at department and core process level is conducted within a three-year timeline. The objectives are further developed into agreements on objectives and outcomes, signed by the heads of department and Board members each year. The agreements outline the objectives, performance indicators and major projects. The Bank of Finland s budget, and the personnel and training scheme as well as evaluation of operational risk management are drawn up as part of action planning. Personnel and budget frameworks Resource deployment and medium-term planning in the departments are guided by personnel and operating cost frameworks. The frameworks are set annually in connection with action planning for the next three years. The procedure contributes to achieving the Bank s strategic objective of being one of the most efficient EU central banks. 48 Bank of Finland Annual Report 2016 Management and personnel

50 Risk management Risk management is part of the Bank of Finland s governance framework and is also linked with action planning. The Bank s risks are divided into strategic, financial and operational risks. Overall responsibility for the provision and governance of risk management and the definition of the level of risk exposure rests with the Bank s Board, but each member of staff is responsible for the management of risks falling within their own job remit. Personnel At the end of 2016, the Bank of Finland staff numbered 376. Of this total, 97% held full-time and 3% part-time positions. A total of 54% of the Bank s staff were men and 46% women. The average age of the staff members is 46.4 years. Bank s work rooted in a good working atmosphere and good management In accordance with our strategy, the Bank of Finland cares for the long-term wellbeing of our staff. Regularly conducted staff surveys indicate that employees feel at ease working at the Bank. The emphasis of management work is on creating a good working atmosphere, motivation and achievement of results. The quality of management is monitored using a leadership index survey, and management work is under constant development saw a follow-up of the 360-degree assessments for the management. The Bank s principles for equality were updated to conform with the amendments to the Non-discrimination Act and the Act on Equality between Women and Men. Continuous renewal of professional skills and working procedures is embedded in the Bank s values. The Bank supports professional development by, among other things, enabling participation in international committees and working groups, on courses offered within the ESCB and through seminars and job rotation. Initial induction material may be accessed online The material for welcoming and inducting new employees was updated in spring Going forward, new employees are initiated into the Bank s activities and employment issues through interactive online studies. The induction course is available according to a timetable that best suits each employee. A new employee s immediate superior and colleagues are responsible for their initiation into the subject matter of the relevant area of responsibility. Human Resources staff support internal networking by organising meetings between new employees and management. Social media in recruitment communications The use of social media in recruitment communications was enhanced in the autumn by introducing the LinkedIn Careers site, which besides announcing job openings also provides information on the central bank as a workplace and on the people working here. In addition, experts were trained in the creation of LinkedIn profiles. In the future, expert profiles will be more visible as part of job advertisements. Responsible summer jobs The Bank of Finland supports youth employment by annually offering summer jobs to about 50 students. In 2016, the Bank took part in the nationwide Responsible Summer Job campaign, aimed at challenging employers to provide more and better summer jobs for young people. Summer work at the Bank was perceived as being interesting, and summer trainees found the tasks diverse and responsible. Team spirit and the good working atmosphere were also much praised. Summer trainees assigned the Bank an overall job rating of 3.8 (on a scale of 1 to 4). Management and personnel Bank of Finland Annual Report

51 Table 6. Human resource management highlights Staff size Head count Man years Number of newly retired employees Average effective retirement age 60.9 v 60.8 v Staff structure Average staff age 46.3 v 46.4 v Proportion of experts and superiors 77% 81% Proportion of women 45% 46% Salaries and bonuses Salaries in relation to market salaries at the Bank of Finland 2 99% 100% Negotiated increases 16 e 0.43% Bonuses as a proportion of payroll Average pay for women / average pay for men 99% 99% Competence Training costs / payroll 3.3% 3.2% Training days / man-year Education level index Wellness at work Absence rate Employee satisfaction index Figures refer to the Bank of Finland, unless otherwise mentioned. Figures referring to the Financial Supervisory Authority are published in the FIN-FSA Annual Report. 2 The reference group in the HAY market salary survey is made up of organisations representing the banking and financial sectors, public sector, and industrial and service sectors. The Bank of Finland's remuneration policy is targeted at the median level of the HAY market salary survey for all organisations (basic salary + benefits). The survey also includes FIN-FSA's staff salaries. 3 Education level index is calculated from the basic level of education of staff. The index varies between 1 and Bank of Finland Annual Report 2016 Management and personnel

52 Budget and operating expenses Budget for the Bank of Finland Ongoing objectives-driven budgetary guidance and human resources planning have led to improvements in the costefficiency of the Bank of Finland s operations. The cost-benefit analysis and overall assessment of projects have been upgraded by introducing a separate project model. This enables assessment of aggregate project profitability from the perspective of costs, qualitative benefits and operational risks. In 2016, the Bank of Finland s operating expenses totalled EUR 85.1 million (EUR 75.6 million in 2015). Budgeted operating income amounted to EUR 13.8 million. The Bank s net operating expenses totalled EUR 71.3 million (for more information on operating expenses and the budget, see Table 7). In autumn 2016, the Bank of Finland s budgets for were drawn up and, of these, the Board ratified the budget for The budgets for will be ratified at a later date. Operating expenses and related objectives included in the budgets are monitored on a regular basis. The Board evaluates operations and costefficiency on the basis of quarterly budgetary monitoring. Pension fund budget The pension fund s operating expenses for 2016 totalled EUR 29.2 million (EUR 28.5 million in 2015). Pensions paid (EUR 26.8 million) constituted the largest cost item. This comprises EUR 27.2 million in pensions and EUR 0.4 million in advances from the Unemployment Insurance Fund. Operating income amounted to EUR 11.6 million (Table 8). Pension fund expenses are estimated to increase slightly during the coming budgetary period. The pension fund s operations are presented in its own annual report. Table 7. Budget for the Bank of Finland 1. Operating expenses and income Outturn 2016 Budgeted 2017 EXPENSES Staff expenses Staff-related expenses Other expenses DEPRECIATION Total Banknote acquisition costs Banking service expenses Total operating expenses INCOME Banking service income Real estate Other income Services to FIN-FSA Total income Net Investment Real estate investment Head office premises Vantaa premises Other premises IT equipment and software Cash handling machines Security equipment Other Total investment Due to rounding, totals/sub-totals may not add up. Table 8. Budget for the Bank of Finland pension fund 1. Operating expenses and income Outturn 2016 Budgeted 2017 EXPENSES Staff expenses Pension fund activities expenses Pension fund real estate expenses DEPRECIATION PENSIONS Pensions paid Total expenses INCOME Employment pension contributions Internal rents Total income Net Due to rounding, totals/sub-totals may not add up. Management and personnel Bank of Finland Annual Report

53 Table 9. Budget for the Financial Supervisory Authority 1. Operating expenses and income Outturn 2016 Budgeted 2017 EXPENSES Staff expenses Staff-related expenses Other expenses DEPRECIATION SERVICES FROM THE BANK OF FINLAND Total operating expenses FUNDING OF OPERATIONS Supervision fees Processing fees Bank of Finland contribution to funding Surplus/deficit transferred from previous year Total income Surplus transferred to next year Due to rounding, totals/sub-totals may not add up. Budget for the Financial Supervisory Authority The Board of the Bank of Finland ratifies the budget for the Financial Supervisory Authority (FIN-FSA). In 2016, the FIN-FSA s operating expenses totalled EUR 25.7 million (EUR 26.0 million in 2015). Total income amounted to EUR 25.7 million, of which supervision and processing fees accounted for EUR 23.1 million, while the Bank of Finland s contribution to funding was EUR 1.3 million. The surplus for the financial year was EUR 1.3 million. This will be taken into account in the following accounting period when setting supervision and processing fees (Table 9). Investments for 2016 totalled EUR 0.9 million. The FIN-FSA s operations are presented in its own annual report. 52 Bank of Finland Annual Report 2016 Management and personnel

54 Environment The Bank of Finland ensured that we met our environmental responsibilities in 2016 by deciding to introduce district cooling at our Helsinki premises and by increasing the capacity of free cooling at our Vantaa premises. The consumption of office paper and the number of outputs could be reduced thanks to a new printing system (table 10). A new telephone system based on a mobile switchboard and a decision to migrate to an environment of portable workstations improved the staff s possibilities to work regardless of location. Staff members increasingly used their workstations video conference system for internal meetings and external contacts. We monitor the environmental impact of our operations using an environmental performance indicator that is proportionate to operating expenses. In 2016, for every thousand euro of operating expenses, the Bank generated kg of CO 2 emissions. The equivalent volume in 2015 was kg of CO 2 emissions. Central banks are responsible for their own tasks within national currency supply systems but also bear overall responsibility for the smooth functioning of national currency supply. In a demographically small country like Finland, with a concentrated banking system and a downsized branch network, as in the Nordic countries in general, currency supply needs to be efficient. Given that the use of cash as a means of payment has steadily diminished, the Bank of Finland has sought to concentrate its own activities and, in cooperation with private banks and their currency supply organisations, to find solutions for maintaining a well-functioning national currency supply framework. A central bank may seek to save the overall cost of currency supply by, among other things, curtailing its own banknote sorting. This is possible only if the other party to currency supply has already performed the same sorting process. Even so, a central bank always carries out the final sorting in currency supply regarding banknote authenticity and fitness. In the Bank of Finland s sorting for banknote fitness, the unfit rate for euro banknotes is fairly low, which indicates that this sorting is needlessly carried out twice. To reduce double sorting, banks own sorted banknote packages were introduced in Finland as from Accordingly, the Bank of Finland s regional branches have accepted for our night safes mainly packages of banknotes in good condition intended for direct use in ATMs. The central bank does not open or sort these packages, but returns them to depositors the next time they order corresponding banknotes. The Table 10. Bank of Finland's environmental impact Volume Electrical energy consumption (MWh) 8,784 8,436 8,223 Heating energy consumption (MWh) 9,150 8,349 9,059 Consumption of office and publication paper (tonnes) CO 2 emissions from business travel (tonnes) 1,889 1,958 1,821 CO 2 emissions balance (tonnes) 5,793 5,636 5,446 Source: Bank of Finland. Management and personnel Bank of Finland Annual Report

55 Chart 16. Annual totals of banknotes sorted at the Bank of Finland Moving annual total, millions of notes Banknotes sorted at the Bank of Finland, annual total 2. Banknotes sorted at the Bank of Finland, excl. banks own sorted banknote packages 3. Banks own sorted banknote packages, annual total Source: Bank of Finland. Chart 17. Savings from not minting 1 and 2 cent euro coins illion imputed savings in 2016 for avoidance of unnecessary double sorting is around 90 million banknotes (Chart 16). Savings in currency supply in Finland have also been generated as a result of the fact that 1 and 2 cent euro coins have not been launched for active trading. These smallest euro cent denominations have been minted in Finland mainly just for numismatic purposes. The number of the smallest euro cents not minted can be estimated by a calculation where these smallest denominations are assumed to correspond to the average share of other euro area countries, deducted by the number of the smallest denominations minted. For calculating the cost savings, the unit price of these smallest euro cents is considered to be their nominal price. The calculation shows that the cost savings from not minting the smallest denominations have amounted to about EUR 9 million in Finland since the launch of the euro (Chart 17). The elimination of the smallest euro cent denominations has also brought significant savings in currency supply processing costs at shops, banks and professional money handlers operations, albeit it is hard to present an accurate estimate of these savings. 1. Savings from not minting 1 cent euro coins 2. Savings from not minting 2 cent euro coins 3. Savings from not minting 1 and 2 cent euro coins Source: Bank of Finland. 54 Bank of Finland Annual Report 2016 Management and personnel

56 Total risk exposure Financial asset management, monetary policy implementation and other operational activities expose the Bank of Finland to risks. These risks are managed and prepared for by risk buffers. Operational risks are identified, as far as possible, in connection with action planning and managed in daily work on a decentralised basis. Financial assets The Bank of Finland has approximately EUR 17.4 billion worth of financial assets, consisting of foreign reserves, holdings of gold and assets denominated in euro. The financial assets are exposed to exchange rate risks, interest rate risks, equity risks and credit risks. The largest fluctuations in the value of the financial assets are caused by exchange rate risk. This is diversified by investing in the pound sterling and the Japanese yen as well as the US dollar. The bulk of the Bank s financial assets are invested in short-term bonds with an average maturity at the end of 2016 of 1.8 years. The interest rate risk sensitivity of US dollar-denominated investments was increased slightly during the course of The credit risk attached to the financial assets is managed by rating requirements and limits. The aim of investments made on international stock markets is to diversify the risks relating to the financial assets. Monetary policy operations The Eurosystem s monetary policy operations are implemented on a decentralised basis. The operations are based on the premise that the risks and returns are shared jointly, with each country s share determined by its capital key. However, the risks related to the first and second covered bond purchase programmes (CBPP1 and 2) and the public sector purchase programme (PSPP) in respect of government debt are borne individually by each central bank involved. Refinancing operations are conducted with financially sound counterparties and against adequate collateral. The risks inherent in these operations are managed by haircuts and daily valuations applied to collateral assets. At the end of 2016, main refinancing operations accounted for around EUR 39 billion, and longer-term refinancing operations around EUR 557 billion of the total. Targeted longer-term refinancing operations (TLTROs) correspond, in terms of credit risk, to standard refinancing operations, but the applicable interest rate is fixed. The interest rate ultimately charged on borrowing under TLTRO II refinancing operations launched in 2016 depends on counterparties lending to the private sector (Table 11). Under the expanded asset purchase programme (EAPP), the Eurosystem will conduct monthly asset purchases of approximately EUR 80 billion until March 2017, and thereafter of approximately EUR 60 billion until December 2017 (Chart 18). The EAPP consists of the covered bond purchase program 3 (CBPP3), the assetbacked securities purchase programme (ABSPP), the public sector purchase programme (PSPP), and the corporate sector purchase programme (CSPP) launched in June A total of 80% of the PSPP is implemented in such a way that the national central banks assume responsibility for the risks involved in the assets they have purchased. This share includes government and government-related debt. The Bank of Finland s PSPP purchases mainly comprise Finnish government bonds. Purchases of bonds issued by European institutions, which are subject to a regime of loss-sharing, account for 10% of the programme. In addition, the ECB s share of purchases under the programme is 10%. The size of the PSPP at the end of 2016 was EUR 1,255 billion. The Bank of Finland s balance sheet included around EUR 18.9 billion in Finnish government bonds and government-related bonds purchased under this programme. Under the Securities Markets Programme (SMP), terminated in 2012, the Eurosystem purchased Spanish, Irish, Management and personnel Bank of Finland Annual Report

57 Table 11. Volumes of monetary policy operations at the end of 2016 illion Eurosystem Bank of Finland's calculated contribution* Refinancing operations 595,874 10,636 Covered Bond Purchase Programme 223,217 3,984 Securities Markets Programme 102,274 1,826 Asset-Backed Securities Purchase Programme 22, Public Sector Purchase Programme 1.254,635 22,395 Corporate Sector Purchase Programme 51, * Calculated as a percentage (1.785%) of total Eurosystem (incl. ECB) operations. Sources: European Central Bank and Bank of Finland. Chart 18. Developments in Eurosystem balance sheet items illion 4,000 3,500 3,000 2,500 2,000 1,500 1, Balance sheet items other than monetary policy items 2. Securities held for monetary policy purposes 3. Other monetary policy operations 4. Longer-term refinancing operations Source: European Central Bank. Italian, Greek and Portuguese government bonds. Securities reaching maturity have continued to reduce the size of this purchase programme. At the end of 2016, the Bank of Finland s SMP shares according to the capital key were as follows, country by country: Spain EUR 357 million, Ireland EUR 126 million, Italy EUR 957 million, Greece EUR 220 million and Portugal EUR 165 million. Also, the total amount of the already terminated first and second covered bond purchase programmes on the Bank of Finland s balance sheet was only EUR 186 million at the end of The total volume of Eurosystem monetary policy operations grew by about EUR 888 billion during the course of The volume of refinancing operations increased by around EUR 37 billion, and of monetary policy purchase programmes by roughly EUR 851 billion. Total risk exposure on the balance sheet The Bank of Finland s total risk exposure is measured using well-established methods. Market and credit risks to the balance sheet are measured by models based on the Valueat-Risk method, with particular emphasis on the worst percentage of the model outcomes. As statistical models fail to provide a full picture of the risks involved, the risk assessment is supplemented with scenario analyses and stress tests to estimate the losses that could be incurred under possible, but improbable scenarios. Total risks to the financial assets and monetary policy operations, in annual terms, amounted to EUR 2.0 billion at the end of 2016 (excl. gold price risk, Chart yy). The calculated risk figure remained almost unchanged from the previous year. As the revaluation account for gold covers more than half the value of the gold, its risk is calculated separately. The gold price risk was EUR 0.7 billion, while the revaluation account for gold was EUR 1.3 billion. In the Notes on risk management section in the Financial statements (p. 89), risks 56 Bank of Finland Annual Report 2016 Management and personnel

58 related to gold are included in the overall assessment. Assets purchased under the expanded asset purchase programme are not valued at market prices. Interest rate movements do, however, affect interest income from new asset purchases and the financing costs of the purchase programmes. Higher financing costs would reduce the Bank s net interest income. Purchases of public sector securities, in particular, increased interest rate risk to the Bank s monetary policy operations in At the end of 2016, the Bank s capital and reserves totalled EUR 9.4 billion. Of this, the primary capital and reserve fund accounted for EUR 2.6 billion, provisions (excl. pension provision) for EUR 3.9 billion and revaluation accounts for EUR 3.0 billion. The Bank of Finland s risk buffers were strengthened in Implementation of monetary policy and safeguarding the stability and functioning of the financial system are core central bank tasks and may entail losses. Preparation for risks means ensuring balance sheet strength by accumulating provisions and capital resources and by reducing risks to financial assets, wherever needed. The Bank of Finland s capital adequacy is sufficient to cover the risks arising from the exercise of its functions Chart 19. Bank of Finland s total risk exposure, capital and reserves excl. gold price risk and gold revaluation accounts EUR bn Risks relating to different scenarios Average loss if the worst 1% of the model occurs 1. Market and credit risk 2. Disposable provisions 3. Disposable revaluation accounts 4. Primary capital and reserve fund 1 Source: Bank of Finland. Items included in capital and reserves Chart 20. Development of risks and risk buffers, excl. gold and gold revaluation account EUR bn Provisions and disposable revaluation accounts 2. Average loss if the worst 1% occurs Source: Bank of Finland. Management and personnel Bank of Finland Annual Report

59 58 Photo: Peter Mickelsson.