MuniFin builds balance sheet strength for sustainable growth

As MuniFin has been growing fast in recent years, the bank is now under the supervision of the European Central Bank (ECB). This means complying with the corresponding regulations, particularly in the field of asset and liability management (ALM). How does the organization deal with the new ALM challenges?

MuniFin, the shortened name for Municipality Finance Plc, aims to promote welfare in Finland through the financing of municipal projects related to basic infrastructure, healthcare, education and the environment. Therefore, a significant portion of its lending is used for socially responsible projects such as building hospitals, healthcare centers, schools, day care centers and homes for the elderly. Finland’s local government sector is characterized by a high degree of autonomy over financial matters and strong credit quality, which is reflected in the high quality of MuniFin’s loan portfolio.

We do 200 to 300 transactions in the funding market, in almost 20 different currencies. This results in quite a bit of complexity.

Pyry Happonen, head of ALM at MuniFin

International player

MuniFin operates domestically, but is an international player, says Pyry Happonen, head of ALM at MuniFin: “We do all of our lending in Finland, but we fund our operations through international capital markets. Traditionally we have been very flexible in terms of funding. Each year we do 200 to 300 transactions in the funding market, in almost 20 different currencies. This results in quite a bit of complexity.”

In the meantime, MuniFin’s balance sheet has grown significantly in the last few years, to approximately EUR 35 billion. Simultaneously, the number of people working at MuniFin has increased to 149. As a result, the bank moved from domestic supervision to European supervision. Together with many developments in the financial markets, this has brought new challenges for MuniFin. European supervision raises the bar continuously regarding risk management.

“We therefore need to stay on top of things”, says Pasi Heikkilä, head of Treasury at MuniFin. “Not just by checking the boxes and fulfilling the requirements. To maintain our profitability and reduce risks, we need to improve the way we work too.”

External requirements and internal goals

According to Heikkilä, the changes bring both challenges and opportunities. “We’ve been directly regulated by the ECB since 2016 and our focus has been very much on complying with all ratios and liquidity requirements. We also want to put more focus on the long-term profitability side. The external requirements and our internal goals can strengthen one another. Both encourage us to look at ALM in different ways and to manage our balance sheet more efficiently.”

In terms of interest rate risk management, MuniFin is compliant. “We can manage our economic value of equity (EVE) and our net interest income (NII),” Happonen explains. “But we also wanted to dive a bit deeper than ticking the boxes and to find an optimal way to manage this risk. We wanted to enhance the capabilities and at the same time, we were looking for a third party to share and discuss our thoughts on our interest rate risk strategy. We therefore engaged with Zanders; to review the strategy and to ensure that we are optimally managing our profitability with regards to interest rate risk. Furthermore, we want to ensure we are fully leveraging the increased data and modeling capabilities.”

Iterative process

Ensuring compliance and simultaneously striving for improved internal risk management has influenced MuniFin’s strategy, says Heikkilä: “It’s an iterative process, a constant development which happens in cycles. For a relatively small company like ours, additional support is welcome. We continuously have active dialogues with our peers. But not all information is open; market participants cannot always share all information. So, in some cases we consult experts like Zanders, to help us with gap analyses so that we can figure out what to further improve on.”

Better quality data

In the current regulatory environment, managing a balance sheet efficiently is not a trivial task, Heikkilä explains. “Balance sheet profitability and risk need to be managed and optimized while considering multiple metrics, like the liquidity coverage ratio (LCR), the net stable funding ratio (NSFR) and the leverage ratio. To ensure liquidity is priced correctly and to have a sustainable profit margin, a robust funds transfer pricing (FTP) framework is required. At the same time, this needs to be done in a cost-efficient manner and with good data and systems.”

To meet these requirements, MuniFin is significantly improving its data and modeling capabilities too, to provide the company with reliable information on a daily basis.

“To ensure liquidity is priced correctly and to have a sustainable profit margin, a robust funds transfer pricing (FTP) framework is required”

Pasi Heikkilä, head of Treasury at MuniFin

“Latency is decreasing”, says Happonen. “We can do analyses and calculations more frequently. In Finland the big banks are investing hundreds of millions in their IT and systems. They are getting rid of legacy systems and bringing in new software, in order to improve quality of data and modeling capabilities to enable good decision-making. This is key in going forward in ALM; subpar data and Excel files no longer cut it. We are also proactive on this front, investing in our data collection and modeling capabilities for better analyses on a more frequent basis, with up-to-date data. And of course, technology helps us to make better strategic choices too, concerning managing interest rate risk, net interest income and so on.”

Green finance

In terms of the future strategy, green finance is a very important topic in MuniFin’s plans. The bank offers green financing, funded by green bonds, for projects that promote the transition to low-carbon and climate resilient growth. Sustainability initiatives and climate change ambitions are increasingly key in financing, according to Happonen.

“On the global bond market many investors are craving for green bonds”

Pyry Happonen, head of ALM at MuniFin

“Green finance is a very big thing for us. We are lending to a lot of domestic green projects, like public transportation. And we report the impact of the green financing we’ve done. On the global bond market many investors are craving for green bonds. The better our ALM strategy, the more optimal our profitability and risk return profile are and the more we can contribute to sustainability too. It means that we need to be sustainable in all senses, so both financially and environmentally.”

Sustainable balance sheet management: Running a sustainable business model requires maintaining a sustainable balance sheet. A stable profit margin and a risk profile that is in line with the risk appetite is essential. Finding the balance between risk and profitability can be a challenging task that requires continuous monitoring and steering. On the one hand, long lending with short funding results in high margins and therefore great profitability, in the short run. However, such a position yields significant risks in the longer run. As interest rates increase, more expensive funding is required, potentially resulting in a negative margin. Only by making the right trade-off between risk and profitability, and therefore between the short-term view and the long-term view, can a sustainable balance sheet be maintained.