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Comments by Kari Parkkonen: Background Report on Finnish Government Guarantee Risks

Finland's Economic Policy Council published their annual report in January 29, 2020. In the report, the Council evaluates the government’s fiscal policy and its employment-promoting policies. As in the previous reports, in addition to fiscal policy, the Council concentrates on fiscal sustainability and on the connections between social security and employment.

One of the background reports of 2019 deals with the Risks of the Finnish Government Guarantee System. Government Counsellor Kari Parkkonen from the Ministry of Economic Affairs and Employment gave his comments in the report launch seminar, in Helsinki, on 29 January 2020.

For more information, including the full EPC 2019 report as well as all five background reports, please see: https://www.talouspolitiikanarviointineuvosto.fi/en/home/

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Comments by Kari Parkkonen: Background Report on Finnish Government Guarantee Risks

  1. 1. RISKS OF THE FINNISH STATE GUARANTEE SYSTEM OF EXPORT CREDITS: Background Report for the Economic Policy Council Report 2019 Comments by the Ministry of Economic Affairs and Employment 29.1.2020 Government counsellor Kari Parkkonen
  2. 2. Introduction; General background • The objective of Export credit system at large is to promote Finland’s economic development by providing internationally competitive financing for exports and domestic ship deliveries. • Two main forms of financing: export credit guarantees granted by Finnvera Plc and export credit loans granted by Finland's Export Credit Corporation (FEC), in addition interest make up –system is to tackle interest rate risks taken care of by FEC • System is based on the international agreement; the Arrangement on Officially Supported Export Credits; this is why all the OECD countries do have arrangements for export credit institutions based on the Arrangement • The main purpose of the Arrangement is to provide a framework for the orderly use of officially supported export credits. The Arrangement seeks to foster a level playing field for official support in order to encourage competition among exporters based on quality and price of goods and services rather than on the most favourable officially supported financial terms and conditions Main elements of the system • Finnvera and FEC is limited to grant financing by the law; rules on outstanding commitment on export credit guarantees which shall not exceed 38 billion and export credit loans which shall not exceed 33 billion euros; also limited to conclude interest equalisation agreements the amount of which shall not exceed 33 billion; these authorization's came into force on 1st of January 2020. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 2
  3. 3. Objectives; main elements • Finnvera’s objectives is to correct any deficiencies that may exist on the financial market; according to international studies there is a market failure on demand for export credit financing in Finland for large transactions especially with long repayment terms and conditions which is supposed to remain stable in the long run and not being dependent on cyclical trends (ATRX e.g., published on 1st of February 2017). • This development has emerged after the financial crisis in 2007-2008. • New provisions of banks concerning their financial standings in Basel III have had an impact. • A market failure is also in export credits to SMEs. • In its operations Finnvera is expected to attain economic self-sustainability. This means that the income received from the company’s operations must, in the long run, cover the company’s operating expenses. The period for reviewing self-sustainability is 10 years for SME and midcap financing and 20 years for export financing. This has been the case with Finnvera. • WTO rules in ASCM agreement; the provisions by governments or special institutions controlled by the government of export credit guarantee at premium rates which are adequate to cover the long-term operating costs and losses of the programmes. • The Arrangement sets out minimum terms and conditions for export credits such as fixed CIRR interest rates, maximum repayment terms, minimum premium rates for credit risks e.g. with the aim to prevent competition in financial terms and conditions. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 3
  4. 4. Financial situation • The structure of Finnish exports is concentrated on certain industrial sectors which are cruise shipping, telecommunications and pulp and paper • In these sectors there is demand for high volume of finance with long repayment terms • In the commercial practice buyers often asks for an offer by an Export Credit Agency (ECA) as a precondition for an order of a project • There is also tough international competition between ECAs to finance projects • The volumes of financing has increased in Finland; therefore the authorizations needed to be increased in order to safeguard the working of the system • This is mainly due to the exceptional situation in the cruise shipping sector; all the dockyards in Europe have full order stock for three to four years to come • The demand for finance is for loans with fixed CIRR-interest rates. • Based on the forecast of the possible export projects by Finnvera in the near future the amount of guarantees and export credit loans are to decline during 2020-2021. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 4
  5. 5. Economic Impacts: a short overview • Many studies have been made recently on this issue. • In 2018, exports covered by state’s export credit guarantees accounted for 4.8 per cent of Finland's total exports. The average figure for 2011–2017 has been between 3.5 to 5 per cent. • Several studies have been conducted on the effects of Finnvera Plc's export financing; In 2009–2013, the total effect of export-guaranteed transactions in Finland was over 10 billion. • According to a study conducted by Etla in 2018 (Aki-Yrkkö and Kuusi 2018), the total employment effects generated by key companies in the public export finance sector in the shipping and telecommunications industries in 2017 were approximately 11,000 employees. • According to the Etla Study one billion euros invested in a cuiseship generates 630 million euros in added value. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 5
  6. 6. Intstruments to mitigate risks I • Possible guarantee losses of the Finnvera’s guarantees are entered into the profit ina loss account in a certain year • Possible yearly losses are covered from a special guarantee fund which is in the balance sheet of Finnvera. The amount of the fund werw at the end of June 2019 773 million euros • Secondly losses are covered from the Guarantee Fund of the State, where the amount of funds were at the end of June 2019 681 million euros • These two funds constitute together so called buffer funds to the amount of 1,45 billion euros. • The basic idea is that the outstanding commitments of Finnvera and FEC should be covered by these amounts when the economic capital of the commitments is calculated using the concepts of VaR and CVaR. • Thirdly losses are covered from the state budget. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 6
  7. 7. Instruments to mitigate risks II • Commitments taken into account in the calculation consists of export credit guarantees disbursed; the amount of which was at the end of June 2019 about 10,4 billion euros. • We have come to the conclusion that the commitments are covered by the buffer funds, 1,45 billion euros. • We have made a calculation that the estimated risks of the whole outstanding commitments in 2023 would be about 1 billion euros. • The next chart shows the result of Finnvera from 2000 to 2018. It also includes net losses and expected losses. You can see, that Finnvera has had a positive result in each of the years 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 7
  8. 8. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 8
  9. 9. Comments on the Report I 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 9 • The report is a good addition to the studies made in this area and is very interesting. • The risk outputs VaR and C-VaR are also calculated by Finnvera but the methods used differs and leads to significantly different results. • The major difference in calculation is that disbursed guarantees are used by Finnvera as a basis for calculation of economic capital. This is because credit risk can arise only on those loans which are drawn. There is a reference to this mechanism on page 11 when it is said that when the buyer makes payments to the Finnish exporter the guarantee exposure to the Finnish exporter declines. If the loan which is guaranteed by Finnvera is not at all disbursed to the buyer there is no obligation by the buyer to make any payments until the date of disbursement. So no defaults can happen until that date. • This is actually a major general problem with the figures. The question is how to interpret liabilities. You have different possibilities. You can take into account all the guarantees agreed or only loans paid to the buyer which are guaranteed by Finnvera. In addition you can count also offers of guarantees.
  10. 10. Comments to the report II • You can use different base figures for calculation depending on the need. If there is a need to calculate the solvency reguirement according to Basel III you take into account guarantees agreed and offers given. Also this figure is followed by the MEE and is calculated by Finnvera. • Finnvera has delivered all the data to be used in the report. It is still difficult to get the same results as in the report due to different methods used. • The impact of the export credit system is important and it has been shown in many studies. MEE and Finnvera will follow closely the different impacts of the system. • Finnvera has a reinsurance policy. The amount reinsured is about 1,3 billion euros at the end of June 2019. It is not clear if this is taken into account in the report. Also it is difficult to assess how the buffer fund, 1,45 billion euros, has been taken into account. • The result of the report on page 21 table 3 shows that the expected shortfall (C- VaR) could be about 870 million euros which is higher than similar estimates given by Finnvera. Is it perhaps a result of chosen macro factor e.g. world GPD? • What comes to the impact of risk consentration the expected shorfall conditional that 1 % cut-off level is exceeded (C-VaR) is around 247 million euros, which is surprisingly low figure considering disbursed guarantees. 30.1.2020Työ- ja elinkeinoministeriö • www.tem.fi 10