The Swedish model for bank resolution

As the banking and currency crisis was growing deeper, the government was forced to respond so as to maintain the stability of the financial system. The approach adopted developed piecemeal. Initially, measures were taken on an ad hoc basis. Eventually, as the crisis started to emerge as a major threat to the banking system, policymakers were forced to respond in a more consistent manner. This process developed into the Swedish model for bank resolution. In retrospect, this model consists of several features. The core is composed of the following seven elements.¹⁵

3.1 Blanket guarantee of bank liabilities

The government, in cooperation with the opposition, announced in a press release on 24 September 1992 that depositors as well as other counterparties of Swedish commercial banks and Swedish financial institutions in which the State was involved were to be fully protected from any future losses on their claims. According to the press release, the government was going to ask the parliament, the Riksdag, to agree on a legislative package later that autumn to address the financial turmoil.

The press release declared that the purpose of the blanket guarantee was that "households, enterprises and other holders of claims can feel secure".¹⁶ However, the immediate reason for the press release was actually the fear of losing foreign financing facilities. Swedish banks were heavily dependent on foreign financing. If this funding were to dry up, it would not be possible for the Riksbank to maintain the pegged krona rate.¹⁷ For the policymakers there was no alternative but to issue a blanket guarantee to support the krona.

In the currency turmoil of September 1992, where speculation had forced the central banks of the United Kingdom, Finland and Spain, among others, to let their currencies float, the peg of the krona came under heavy speculative attacks. The blanket guarantee—already a drastic measure in itself—was thus an attempt to dispel foreigners’ fears that Swedish commercial banks would not be able to meet their financial obligations. The guarantee was successful in the sense that foreigners’ confidence in the solvency of the Swedish commercial banks remained intact.

In addition, the blanket guarantee proved highly beneficial, as it expanded the options for the Riksbank to support commercial banks regardless of their financial position. Through the press release, the Riksbank was given the option of lending to any commercial bank operating in Sweden, even to those that were on the brink of insolvency, because the press release represented a State guarantee for the liabilities of the banks.¹⁸

3.2 Political unity

The blanket guarantee of September 1992 was based on an agreement between the government and the political opposition. This spirit of political unity became a central feature of the Swedish model of bank resolution policy from the very start. This unity was initially created by the determination of the political parties to defend the pegged exchange rate of the krona, but it persisted throughout the crisis, even after the floating of the krona.

The leadership of both political camps knew that behind the crisis lay a legacy of policy measures taken by two successive governments, first by the Social Democratic government of 1982–91, which initiated the financial deregulation in the mid-1980s and subsequently introduced the policy changes that caused the sharp increase in real interest rates and, secondly, by the center-right government that came into power in the election of autumn 1991, inheriting both the financial imbalances of the boom years and the ensuing bust and emerging depression.

Political unity guaranteed the passage through parliament of measures to support the financial system. In addition, representatives of the opposition had a full insight into the resolution process, thus maintaining political accord.

3.3 Swift policy action

Once it was fully understood that a serious financial crisis was in the making, the government, the parliament and the Riksbank responded by taking decisive steps to support the financial system and, particularly, banks in distress. In this way the confidence of depositors and counterparties in the financial system was strengthened at an early stage of the financial crisis. This made it possible to maintain confidence throughout the resolution of the crisis at a relatively low political cost. Swift action kept any uncertainty regarding policy measures to a minimum.

3.4 Adequate legal and institutional framework based on open-ended funding

In December 1992, the Swedish Parliament by an overwhelming majority passed legislation to establish a Bank Support Authority, the Bankstödsnämnd, as envisaged in the press release of 24 September 1992. The parliament decided that the Bankstödsnämnd was to be given open-ended funding, not a fixed predetermined budget. This was a deliberate choice in order to avoid the risk of the Bankstödsnämnd being forced to go back to the Riksdag to ask for additional funding at a later stage.¹⁹ The open-ended funding underpinned the credibility of the bank resolution policy. It clearly demonstrated that there were no political misgivings about the financial commitment to support the banking system.

The Bankstödsnämnd was set up as an independent agency at a distance from the government, the Riksbank and the Finansinspektion (the financial supervisory authority). This construction fostered credibility and trust in its operations. The Social Democratic opposition was given full insight into its activities. It was staffed by professionals and it began operation in the spring of 1993, shortly after it was established.²⁰ It worked closely with the Riksbank, the Finansinspektion and the National Debt Office. In the few cases when these institutions were not in agreement, the Ministry of Finance acted as arbitrator.²¹

3.5 Full information disclosure

From the very start, the Bankstödsnämnd sought to obtain a clear picture of the financial problems facing the financial institutions through due diligence. Even before it began its work, and in its early stages, it tried to draw—whenever appropriate—on the available expertise for dealing with ailing banks by consulting and using external experts, many of whom were recruited from abroad. Banks that turned to the Bankstödsnämnd with requests for support were obliged to give full disclosure of all their financial positions, opening their books completely to scrutiny. This requirement facilitated the resolution policy, as well as making it acceptable in the eyes of the public.

3.6 Differentiated resolution policy

Banks that turned to the Bankstödsnämnd were dealt with in a way that minimized the moral hazard problem. In short, the aim was to save the banks—not the owners of the banks. By forcing owners of banks to absorb losses, public acceptance of the bank resolution was fostered. In this way, taxpayers were likely to feel that the policy was fair and just.

The general strategy was to divide the banks into three categories, depending on whether the statutory capital adequacy ratio would be breached and, if so, whether this breach was temporary. The first category included those banks that might deteriorate towards the capital adequacy limit, but would subsequently be able to achieve enhanced solvency on their own; the second category covered those that might fall below the limit for a time, but would eventually recover; and the third category was for those that were expected not to recover. Each of these three categories was treated differently by the Bankstödsnämnd.

Two bank asset management corporations (AMC) were set up to manage the bad debt (nonperforming loans) of two financial institutions, Securum as AMC for Nordbanken and Retriva as AMC for Gotabanken, as part of the resolution policy, as had been the case in other countries. A novel approach was adopted which involved splitting the assets of an ailing bank into "good" and "bad" assets, and then transferring the "bad" assets to the AMC, principally to Securum.²² In addition, when assets were placed under the administration of Securum and Retriva, they were assigned low market values in the due diligence process, effectively setting a floor for asset values. Because market participants did not expect prices to fall below this level, trading was maintained.²³

In the long run, i.e., about 10–15 years, the two bank AMCs proved to be successful in the sense that the fiscal cost of supporting the financial system was roughly balanced by the revenues received through the liquidation of the asset holdings of the bank AMCs.

3.7 The role of macroeconomic policies in ending the financial crisis

The bank resolution policy in Sweden was greatly facilitated by the design of monetary and fiscal policies. These measures allowed the Swedish economy, and hence the financial system, to recover fairly rapidly.

The fall of the pegged exchange rate of the krona on 19 November 1992 due to speculative attacks turned out to be an important move toward the recovery. Once the krona was floating, it depreciated sharply—by nearly 30 per cent. In the years that followed, exports became the engine of the Swedish economy.

Once the krona was floating, monetary policy was able to focus on domestic conditions. The Riksbank gradually lowered interest rates. The vicious circle of falling asset prices was halted. The ensuing fall in interest rates eased the pressure on the banking system, as the economy started to recover. In July 1996, the crisis legislation and the blanket guarantee were abolished.

Fiscal policies were supportive too. The government allowed huge deficits to develop during the crisis, mainly as a result of the workings of automatic stabilizers. The bank support policy contributed to the rise in the deficit. Viewed in an international context, the Swedish budget deficit grew exceptionally rapidly.

In short, the rapid recovery of the Swedish economy greatly facilitated the bank resolution policy. As soon as the economy was expanding, pressure on the banking system started to lessen. Balance sheets were strengthened. The banking system became profitable again.²⁴

3.8 Was the Swedish bank resolution a success?

The Swedish bank resolution policy is commonly regarded as successful in the international policy debate, although there are no firm criteria on how to evaluate resolution policies.²⁵ One reason for this positive view is the fact that the banking system continued to function during the crisis, there were no bank runs, hardly any signs of a credit crunch emerged, and the banking system was swift to move out of the crisis. The banking system remained largely privately owned and became profitable shortly after the crisis.²⁶

The exceptions to this rosy picture are Nordbanken and Gotabanken. Nordbanken, previously a government-owned bank that was partially privatized (25%) in the late 1980s, was renationalized. Gotabanken was taken over by the government and amalgamated with the former Nordbanken after the default of the bank holding company, Gota AB. The consolidated Nordbanken, however, was eventually privatized and emerged as a successful venture in the form of Nordea, now the first true pan-Nordic bank, currently active in Denmark, Finland, Norway and Sweden.

Another reason for taking a positive view of the Swedish approach is that the net fiscal cost, more commonly referred to as the “cost to the taxpayer”, turned out to be very low or even a gain for taxpayers in the long run.²⁷ The gross fiscal cost for the bank support policy initially amounted to 3.6% of GDP.²⁸ By now, some 15 years after the crisis, the cost to the taxpayers is likely to have been repaid after the liquidation of the assets that were taken over by government institutions. The best estimate available, at least so far, suggests that the fiscal outlays for supporting the banking sector were recovered.²⁹

The Swedish crisis management was also a domestic affair. No international organizations like the International Monetary Fund (IMF) were involved, which probably contributed to public trust in the process.³⁰ Nevertheless, mistakes were made along the way, although these have not received as much attention as the policy successes. For example, the Financial Supervisory Authority (Finansinspektionen) tightened the accounting rules as the crisis evolved, putting additional pressure on the banking system.³¹ Complaints were made that even firms with a good credit record were transferred from commercial banks to AMCs, and thus left without an ordinary bank connection.³² However, these mistakes are minor in comparison to the positive effect of the overall policy of managing the financial crisis.

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