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Top-down restructuring of markets and institutions: the Nordic banking crises

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Abstract

This paper explores the lessons that can be learned for the future resolvability and successful reorganization of problem banks from the experience of successful resolutions in Denmark, Finland, Iceland, Norway and Sweden over the last 25 years. The Nordic countries used all of the new tools that will be available following the passing of the Bank Recovery and Resolution Directive. There were difficulties with them, which will provide valuable experience, but it is likely that they will work well in the future. Experience with bailing in is limited but suggested problems of valuation in writing down and larger writedowns than might be anticipated. While the current drive to ensure that only private sector money is used, the predilection for the continuation operation of most banks other than smallest and the extent to which public funds were committed, suggest that the taxpayer is likely to be involved in strategic cases in the future. In particular, the guarantee funds available were insufficient and had to be topped up by the state. Hence, the new resolution funds in the EU may similarly need augmenting in a crisis. However, almost all the main banks involved in the Nordic resolutions were primarily national and retail. Where they involved cross-border operations, as in Iceland, the results were very messy. While many were national SIFIs they only became regional SIFIs as a result of the reorganization after the resolutions. Whether the resolutions could be performed so smoothly for these new larger international banks is not readily verifiable from the Nordic experience.

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References and notes

  1. Indeed, it is worth noting that Finland has again been experiencing economic, but it is to be stressed, not banking, difficulties since the GFC, as it has received further shocks from the decline of Nokia and the paper industry and the sanctions against Russia. This time, as a member of the euro area, it has not been able to let its exchange rate fall and let improved competitiveness help a further restructuring in that way

  2. Ingves, S. and Lind, G. (2009) Is the Swedish model for dealing with a banking crisis still valid? In: S. Ingves, G. Lind, M. Shirawawa, J. Caruana and G.O. Martinez (eds.) Lessons Learned from Previous Banking Crises: Sweden, Japan, Spain, and Mexico. Washington DC: Group of Thirty (Occasional Paper 79), 8, question whether the Swedish ‘twists’ to the generally recommended approaches would work equally well in other environments, although their paper is explicitly a ‘lessons learned’ exercise.

  3. See Ingves and Lind (2009).

  4. Its loan losses and provisions were nearly 10% of the loan stock in 1991-3; see Vastrup, C. (2009) How did Denmark avoid a banking crisis? In: L. Jonung, J. Kiander and P. Vartia (eds.) The Great Financial Crisis in Finland and Sweden: The Nordic Experience of Financial Liberalisation. Cheltenham: Edward Elgar, pp. 245–264.

  5. The Faroe Islands did however experience a banking crisis in 1992-3. The main domestic banks failed and were bailed out by the taxpayer. The two main banks were amalgamated and nationalized (Vastrup, 2009); see also http://www.voxeu.org/article/europe-s-pre-eurozone-debt-crisis-faroe-islands-1990s, accessed 10 May 2016, which points out that the high level of public debt that this led to provides an interesting precursor for the problems of the highly indebted euro area countries that have faced bank losses since 2010.

  6. See Vastrup (2009).

  7. Non-bank financial institutions were also closed by the Danish FSA (Finanstilsynet); see Mølgaard, E. (2004) Avoiding a crisis: lessons from the Danish experience. In: D.G.Mayes and A. Liuksila (es.) Who Pays for Bank Insolvency? Basingstoke: Palgrave-Macmillan, pp. 222–241.

  8. See Poulsen, U.L. and Andreasen, B.L. (2011) Handling distressed banks in Denmark. Danmarks Nationalbank Monetary Review 3(1): 81–96.

  9. Most calculations relating to the impact of bailing in are hypothetical, based on the structure of liabilities and the size of losses in banks which used other techniques; see Conlon, T. and Cotter, J. (2014) Anatomy of a bail-in. Journal of Financial Stability 15: 257–263.

  10. See Mølgaard (2004).

  11. An asset management company was formed in just one case.

  12. See https://www.finansielstabilitet.dk/Default.aspx?ID=750.

  13. Technically this was a new bank/old bank split, with all aspects of the bank, except the shareholder and subordinated liabilities necessary to cover the estimated losses being taken into a new bank which was a subsidiary of Finansiel Stabilitet. All of this was to be organized over a weekend so that the new bank could reopen on Monday morning.

  14. Banks could choose whether to enter the resolution scheme or simply opt for normal insolvency.

  15. See Vale, B. (2004) The Norwegian banking crisis. In: T.G. Moe, J.A. Solheim and B. Vale (eds.) The Norwegian Banking Crisis. Oslo: Norges Bank Occasional Paper No. 33, pp. 1–21.

  16. There was a Commercial Bank Guarantee Fund (CBGF) and a Savings Bank Guarantee Fund (SBGF) of which membership in the two sectors was compulsory. See Wilse, H.P. (2004) Management of the banking crisis and state ownership of commercial banks. In: T.G. Moe, J.A. Solheim and B. Vale (eds.) The Norwegian Banking Crisis. Oslo: Norges Bank Occasional Paper No. 33, pp. 179–207, for a description.

  17. See Sandal, K. (2004) The Nordic banking crises in the early 1990s: resolution methods and fiscal costs. In: T.G. Moe, J.A. Solheim and B. Vale (eds.) The Norwegian Banking Crisis. Oslo: Norges Bank Occasional Paper No. 33, pp. 77–115.

  18. To ensure a measure of control the GBIF gained representation on the CBGF and SBGF boards and the banks themselves were required to have guarantee fund nominees on their boards if they were receiving the capital injections.

  19. See Wilse (2004).

  20. See Sandal (2004).

  21. See Sandal (2004).

  22. See Wilse (2004).

  23. The GBIF was eventually closed in 2002, having sold its remaining shares at market prices to the SBIF and the SBIF itself was wound up in 2004 and its shares transferred to the Ministry of Trade and Industry

  24. See Jennergren, L.P. (2001) The Swedish Finance Company Crisis: Could it have been Avoided? Working Paper in Business Administration 2001:6, Stockholm School of Economics.

  25. See Englund, P. and Vihriälä, V. (2009) Financial crisis in Finland and Sweden: similar but not quite the same. In: L. Jonung, J. Kiander and P. Vartia (eds.) The Great Financial Crisis in Finland and Sweden. Cheltenham: Edward Elgar, pp. 71–130.

  26. Macey, J.R. (1999) Are bad banks the solution to a banking crisis? SNS Occasional Paper No. 82, August, available from http://www.docstoc.com/docs/37731705/, accessed 11 September 2014, argues that if Nordbanken had been split up earlier the losses would have been smaller. Because Nordbanken had the weight of the state behind it, it could delay where others would not be able to.

  27. See Sandal (2004).

  28. See Sandal (2004).

  29. See Ingves and Lind (2009).

  30. See Honkapohja, S. (2014) Financial crises: lessons from the Nordic experience. Journal of Financial Stability 13(C): 193–201.

  31. See Nyberg, P. and Vihriälä, V. (1994) The Finnish banking crisis and its handling. Bank of Finland Discussion Paper 7/94.

  32. These private shareholders were bought out when the GGF acquired the bank from the Bank of Finland. Sandal (2004).

  33. See Nyberg and Vihriälä (1994).

  34. Englund and Vihriälä (2009) suggest that these certificates were a Finnish innovation, designed to provide Tier 1 capital without taking ownership of the bank.

  35. Suomen Työväen Säästopankki.

  36. Unlucky of course from the perspective of the creditors who lost heavily in 2008—those losses would have been much smaller had the banks needed restructuring earlier.

  37. See Benediktsson, H., Guðmundsson, M., Sighvatsson, A. and Zoega, G. (2004) Iceland, interaction of monetary and financial stability in a small open economy: the case of Iceland. SUERF-Seminar in Iceland, June 3-4, ‘Interaction of Monetary and Financial Stability in Small Open Economies’, Central Bank of Iceland, Reykjavik.

  38. The Governor of the Central Bank expressed it: The developments in the Icelandic economy towards the end of last decade and into this one resembled in many ways those experienced in some of the other Nordic countries a decade earlier. Needless to say, and in view of the experience of other Nordic countries, these developments caused considerable concern about the underlying stability of the financial system. The Central Bank candidly expressed these concerns in its financial stability reports, most notably in the spring of 2001. At that time the IMF also issued its Financial Stability Assessment which questioned the strength of the financial system in Iceland in view of the tremendous imbalances in the economy and what was perceived to be an underlying weakness in the banking institutions. The IMF identified a potential risk of a rapid depreciation of the currency, which it felt could further weaken the banks and pose a threat to them. (Gunnarsson, B.I (2004) Interaction of monetary and financial stability in small open economies. Available at http://www.bis.org/review/r040610e.pdf, accessed 8 September 2014, p. 2)

  39. See Sigurðson, J. (2004) Small countries, large multi-country banks: a challenge to supervisors—the example of the Nordic-Baltic area. In: D.G. Mayes and A. Liuksila (eds.) Who Pays for Bank Insolvency. Basingstoke: Palgrave Macmillan, pp. 142–163.

  40. See House of Commons Treasury Committee (2009) Banking Crisis: The Impact of the Failure of the Icelandic Banks, Fifth report of the session 2008–2009, HC 402.

  41. See Jännäri, K. (2009) Report on Banking Regulation and Supervision in Iceland: Past Present and Future. Reykjavik: Prime Minister’s Office.

  42. The Reserve Bank of New Zealand has suggested that the impact of a market solution on GDP is likely to be about half that of one that involves closure; see Reserve Bank of New Zealand (2012) Regulatory Impact Assessment of Pre-positioning for Open Bank Resolution. November, http://www.rbnz.govt.nz/regulation_and_supervision/banks/policy/5014272.pdf, accessed 7 April 2015.

  43. This predilection is not unique to the Nordic countries. Northern Rock was saved in the UK despite having only 2% of UK banking deposits.

  44. See Mølgaard (2004, 233).

  45. See Ingves and Lind (2009) and Vale (2004).

  46. See Nyberg and Vihriälä (1994) and Mølgaard (2004).

  47. See Bair, S. (2012) Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself. New York: Free Press, for the case of mortgages in the US.

  48. See Vale (2004).

  49. See Vale (2004).

  50. See Macey (1999).

  51. See Ostrup, F., Oxelheim, L. and Wihlborg, C. (2009) Origins and Resolution of Financial Crises; Lessons from the Current and Northern European Crises. Research Institute of Industrial Economics Working Paper No. 796.

  52. See Ostrup et al. (2009).

  53. See Ostrup et al. (2009).

  54. See Englund and Vihriälä (2009).

  55. Ingves and Lind (2009, p. 20).

  56. See Hoskin, K. and Woolford, I. (2011) A primer on Open Bank Resolution. Reserve Bank of New Zealand Bulletin 74(3): 5–10.

  57. See Poulsen and Andreassen (2011).

  58. See Macey (1999)

  59. Ingves and Lind (2009, p. 20) argue that ‘The sale should take place when the price was optimal, taking account of future expected prices and financial and other costs for holding onto the asset.’ While that is the sensible aspiration, the timing can only be a judgement and there are plenty of examples where acquirers have under or overpaid with the benefit of hindsight.

  60. See Nyberg and Vihriälä (1994).

  61. See Lybeck, J.A. (2016) The Future of Financial Regulation: Who Should Pay for the Failure of American and European Banks? Cambridge: Cambridge University Press, pp. 216–224.

  62. See Government Guarantee Fund (2012). Main events in bank support. Available at https://www.vm.fi/vm/en/04_publications_and_documents/03_documents/Engl_tapahtumat_samassa_korjaus_KYT_022011(1).pdf, accessed 25 August 2014.

  63. There are other exceptions to this ‘rule’, see Englund and Vihriälä (2009). The owners of Första Sparbanken in Sweden received an interest rate subsidy and the owners of STS in Finland were bailed out.

  64. Ingves and Lind (2009, p. 12).

  65. See Ingves and Lind (2009).

  66. See Ingves and Lind (2009, p. 16).

  67. https://www.gov.uk/government/policies/creating-stronger-and-safer-banks/supporting-pages/managing-and-concluding-the-governments-shareholdings-in-certain-uk-banks.

  68. See Nyberg and Vihriälä (1994).

  69. See Mutikainen, T. (1998) Recessions, economic policy and banking: crisis management in Finland in the 1990’s. Ministry of Finance, http://www.vm.fi/vm/fi/04_julkaisut_ja_asiakirjat/03_muut_asiakirjat/discussion_paper.pdf, accessed 10 September 2014.

  70. See Ingves and Lind (2009).

  71. Quoted in Nyberg and Vihriälä (1994).

  72. Quoted in Nyberg and Vihriälä (1994, p.33).

  73. See Nyberg and Vihriälä (1994, Table 4).

  74. Vale (2004, p.15).

  75. The was exemplified by South Canterbury Finance in New Zealand, which substantially increased its exposure and losses after the deposit guarantee was issued in October 2008.

  76. See Englund and Vihriälä (2009).

  77. Sometimes referred to as the Union Bank of Finland or Unitas.

  78. See Koskenkylä, H. (2002) Efficiency and competition in European banking’, Irish Banking Review Summer, pp. 24–40, http://www.patrickmcnutt.com/wp-content/uploads/Summer_2002_Issue.pdf, accessed 8 September 2014.

  79. As shown by Nyberg and Vihriälä (1994, Tables 1 and 2).

  80. See (Vale, 2004).

  81. See Englund and Vihriälä (2009) and Englund, P. (1999) The Swedish banking crisis: roots and consequences. Oxford Review of Economic Policy 15(3): 80–97.

  82. See Macey (1999).

  83. See Macey (1999).

  84. A term used by Adams, C. (2012) The role of the state in managing and forestalling systemic financial crises: some issues and perspectives. In: D. Mayes, P. Morgan and M. Kawai (eds.) The Implications of the Global Financial Crisis for Financial Regulation and Reform in Asia. Cheltenham: Edward Elgar, pp. 200–219, among others, who does not make the mistake of separating the decisions about individual institutions from those relating to the system as a whole.

  85. According to Ingves and Lind (2009).

  86. CoCos form a sort of half-way house here as they are contractual bail in instrument, where the purchaser has agreed that they can be written down or converted into equity at previously agreed trigger points. Thus the contract is voluntary even if the holder has no choice at the point of exercise.

  87. O’Keeffe, M. and Terzi, A. (2014) Politics and financial crisis policy. Paper presented at the UACES conference in Dublin, 1–3 September.

  88. See Ingves and Lind (2009, p. 21)

  89. The 5/6 majority was required because this was equivalent to trying to change the constitution, which requires such a super majority if it is done in a hurry.

  90. See Nyberg and Vihriälä (1994). The Finnish parliament also refused to permit the GGF to create an asset management company to take on the impaired assets of STS-Bank in late 1992. As noted above, the eventual solution was to leave these assets in STS, while the good assets were transferred to STS’s acquirer KOP (Nyberg and Vihriälä, 1994).

  91. See Englund and Vihriälä (2009, p. 105.)

  92. See Jonung, L. (1999) The Swedish model for resolving the banking crisis of 1991-3. Seven reasons why it was successful. European Economy Economic Paper no. 360, DG ECFIN, European Commission, Brussels, available at http://ec.europa.eu/economy_finance/publications/publication14098_en.pdf, accessed 11 September 2014.

  93. See Vale (2004, p. 19).

  94. His other two principles: ‘Owners should be the first in line to take losses’ and ‘The board and senior management responsible for the failure of a bank should not be allowed to continue’ conform to the approach advocated in the BRRD.

  95. Drees, B. and Pazarbaşioğlu, C. (1998). The Nordic Banking Crises: Pitfalls in Financial Liberalization? IMF Occasional Paper 161, Washington DC: IMF.

  96. See Ingves and Lind (2009).

  97. See Mutikainen (1999).

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    David G. Mayes

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Mayes, D.G. Top-down restructuring of markets and institutions: the Nordic banking crises. J Bank Regul 18, 213–232 (2017). https://doi.org/10.1057/s41261-016-0006-z

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