Guarantee Scheme for Banks’ Funding in Finland

The main purpose of the Guarantee Scheme was to support the medium- and short-term financing needs of Finnish banks and mortgage institutions and, in turn, the mortgage market.

To further assist large-scale businesses, the government introduced a State-funded investment program for deposit banks whereby the State Treasury would offer banks interest-bearing subordinate loans that could be considered Tier 1 capital. Additional provisions allowed the State Pension Fund the right to acquire commercial paper “of significant and financially solid Finnish companies” (Mayer Brown 2009).

According to the Act on State Lending and State Guarantees (449/1988), the Ministry of Finance would decide all design decisions relating to the creation of the Guarantee Scheme, with the exception of the overall cap. Approval for the maximum program size was granted by legislative vote in Parliamentary Decision No EV 110/2008 vp of December 12, 2008.

Having found the proposed framework for the Guarantee Scheme to be in line with State Aid rules, the European Commission issued its “Decision not to raise objections” (IP/08/1705) on November 13, 2008 (European Commission 2008). As discussed in more detail in KDD #5, the need to structure the Guarantee Scheme in such a way as to ensure EC approval significantly influenced the design of certain program features.

This maximum amount remained constant until the second modification of the Guarantee Scheme on December 12, 2009, at which point it was decreased to €17 billion. This decrease in the maximum amount that could be guaranteed was tied to the elimination from eligibility of short-term debt. In addition, the minimum eligible maturity increased from 90 days to 12 months as described below (European Commission 2009c).

Finnish subsidiaries of foreign financial institutions were also eligible for coverage under the Guarantee Scheme.

The applicant could be either a deposit bank or its parent company. If a bank was a member of a group, it could apply either individually or on behalf of the group.

Solvency was determined according to the requirements stipulated in Section 55(1) of the Act on Credit Institutions. At the time of the Guarantee Scheme’s proposal to the European Commission, all Finnish banks were required to maintain a Tier 1 capital ratio of at least 7%; if they could not meet that requirement, the add-on fee payable was 5 bps higher. At the time of the guarantee, all Finnish banks had tier 1 capital ratios of at least 7% (European Commission 2008).

In seeking and obtaining approval from the European Commission for the inclusion of covered bonds, Finnish authorities specifically cited the example of Denmark, where the non-inclusion of covered debt in a guarantee program was seen as resulting in the drying up of that market. As additional safeguards associated with the inclusion of covered debt in the Guarantee Scheme, Finland agreed that the amount of such debt that could be guaranteed would be limited to €250 million and that guaranteed covered bonds would have to mature in 2009 (European Commission 2008).

An exception was made for covered (mortgage-backed) bonds, which could have maturities of up to five years.

Per the April 30, 2009, modification, all eligible debt with maturities greater than 90 days and up to five years could be guaranteed. The Finnish government requested this expansion based on its belief that the initial three-year maturity limit was contributing to the lack of use of the Guarantee Scheme. Up to €16.66 billion (i.e., a third) of the €50 billion program cap was earmarked to guarantee eligible debt with maturities greater than three years and less than five years (European Commission 2009b).  

On December 17, 2009, the European Commission approved a request by the Finnish government to amend the minimum maturity restrictions from 90 days to 12 months.  This request stemmed from Finnish authorities’ belief that financial institutions could now access short-term funding at reasonable prices without relying on any guarantee. The Guarantee Scheme thus covered only those instruments with maturities of between 12 months and five years. A maximum of approximately €5.66 billion (i.e., a third of the reduced budget of €17 billion) could be used to guarantee issuances with terms over three years and up to five years.  (European Commission 2009c).

On February 5, 2009, shortly before implementation, the government modified the original terms of the Guarantee Scheme to allow some short-term debt (those instruments with maturities ranging from 90 days to 12 months) to be rolled over to medium-term debt (unsecured bonds with maturities of up to three years). Participating banks were thus allowed to “renew the previously guaranteed short-term debt as medium term debt and still retain the same State guarantee” (European Commission 2009a). Up to €5 billion of the €50 billion program cap could be rolled over under these terms.  

The individual cap available under this provision equaled the participant’s share of the total lending of all eligible banks as of December 31, 2008. A monthly limit equal to the amount of short-term debt maturing in a given month was also imposed.

Program documents contained no references to restrictions on the currencies that would be eligible for the Guarantee Scheme.

For short-term debt with maturities of up to 12 months, the overall limit equaled the total nominal value of such debt outstanding October 17, 2008. The government also applied a monthly limit equal to the total nominal value of the debt maturing in a given month.

For medium-term debt with maturities of over 12 months and up to five years, the overall limit equaled the total nominal value of the bonds maturing between October 17, 2008, and December 31, 2009. There was no monthly cap imposed on the guaranteed issuance of medium-term debt.

Both Government Decree No. 67 and the ECB’s “Recommendations on Government Guarantees on Bank Debt” provided guidance on the fee structure.

For short-term debt with maturities of up to 12 months, the fee equaled 50 basis points on an annual basis.

For medium-term debt with maturities over 12 months, the total participation fee comprised two separate payments:

1. A fee based on the bank’s CDS spread, determined as follows:
   1.  Banks with CDS data were charged the median value of their five-year CDS spreads from the period spanning January 1, 2007, to August 31, 2008;
   2. Banks with a credit rating but without CDS data (or representative CDS data) were required to calculate an equivalent CDS spread based on a “representative sample of euro area large banks” (European Commission 2008). This derivation was taken over the same time period for the rating category of the bank in question;
   3. Banks with neither a credit rating nor CDS data derived their CDS spread from the median value of the five-year CDS spread over the same time period for the lowest rating category;
2. An add-on fee of 50 bps on an annual basis.    

Guaranteed covered bonds received a special pricing structure consisting of the issuing institution’s CDS spread and a lesser add-on fee of 25 bps on an annual basis.

Regardless of the type or maturity of the eligible debt, the add-on fee increased by 5 bps if the Tier 1 capital ratio of the issuing bank fell below 7%.

Guidance issued by the European Commission in October 2008 on the creation of credit guarantee programs called for the inclusion in programs of a set of safeguards “to minimize . . . distortions and the potential abuse of the preferential situations of beneficiaries brought about by a State guarantee” and “to avoid moral hazard.” This guidance did not specify exactly what safeguards a program should include, but required “an adequate combination” of elements, including restrictions on advertising based on the guarantee, balance sheet growth, share buybacks, and executive compensation, some of which Finland adopted (European Commission 2008).

The Finnish Financial Supervisory Authority was to be responsible for ensuring that the aggregate growth in balance sheet volume of participating banks not exceed the higher of:

1. “The annual rate of growth of Finnish nominal GDP in the preceding year,
2. “The average historical growth of balance sheets in the Finnish banking sector during the period 1987–2008 (Quarter 3), or
3. “The average growth rate of the balance sheet volumes in the banking sector in the EU in the preceding months” (European Commission 2008).

Additionally, the government imposed restrictions on wage increases, bonus payments, increases in board remuneration, and bank executives´ severance packages. Relatedly, banks were generally not allowed to engage in activities that would not have otherwise occurred in the program’s absence, such as the mass marketing of the Guarantee Scheme, “except when required by law or other regulations” (European Commission 2008).

Participating banks were also prohibited from creating buy-back programs for their own shares. Relatedly, savings banks were not allowed to buy or otherwise acquire against payment their bank fund shares, while cooperative banks were not allowed to refund cooperative capital, additional cooperative capital, or cooperative investment capital “for any other reason than termination of membership in the cooperative” (European Commission 2008).

Before the program was implemented, the restrictions on balance sheet growth and buy-back programs were repealed in the February 5, 2009, modification of the Guarantee Scheme terms. All conditions on compensation and management wages were also modified to reflect the principles of the competitive remuneration for State-owned and associated companies (European Commission 2009a).

Due to legal restrictions on the transfer of these mortgages, this requirement was repealed in the April 30, 2009, modification to the Guarantee Scheme.

For any institution defaulting on its liabilities and triggering the guarantee, Finnish authorities committed to file individual restructuring/liquidation plans within six months (European Commission 2008).

On April 30, 2009, the European Commission approved a modified extension of the Guarantee Scheme issuance window to December 31, 2009. On December 17, 2009, the EC  approved a second prolongation of the program to conclude on June 30, 2010. These extensions occurred despite the fact that the Guarantee Scheme had not yet been used. In their requests for extensions, Finnish authorities noted that while Finnish banks had access to medium-term funding without resort to the Guarantee Scheme, such access was fragile and could be quickly jeopardized based on any negative news (European Commission 2009c). Thus, the extension of the Guarantee Scheme, despite its lack of use appears to have been a precautionary step intended to provide a backstop should conditions worsen.