COMPARING FINANCIAL SYSTEMS. Lesson 10 Financial systems in Northern Europe

Transcription

1 COMPARING FINANCIAL SYSTEMS Lesson 10 Financial systems in Northern Europe

2 What you will learn in this lesson The main features of the banking systems in Nordic countries The main features of Nordic non-deposit-taking institutions The origins of Nordic banking crises in the 1980s and 1990s

3 Introduction The Nordic countries (Denmark, Norway, Sweden and Finland) are all small economies. However, the four countries as a whole have 24 million inhabitants and a total GDP that matches that of Spain plus Portugal. Furthermore, the institutions of money, banking and finance in these countries are of general interest because of: 1. their history; 2. the diversity of their monetary policy frameworks. They also enjoy a relatively high degree of cultural homogeneity. If their financial institutions continue to merge and cooperate, the region will have an integrated financial market that ranks among the 10 largest in the world.

4 Northern central banks The Bank of Sweden (Sveriges Riksbank), as we saw, is the oldest existing central bank in the world. Its history as a public institution dates back to 1668, when it succeeded the world s oldest note-issuing bank, Stockholm Banco (also known as Palmstruchska Banken). Under the auspices of the parliament, the Riksbank (or, as it was called then, Riksens Ständers Bank) was actually in operation long before private banks started to do business in the mid-nineteenth century, when the state began to promote private banking in order to develop Sweden s industries and commerce. The second decade of the nineteenth century saw the foundation of the Bank of Finland (Suomen Pankki ), in 1811, and the Bank of Norway (Norges Bank), in 1816.

5 The Danish central bank The Danish central bank (Danmarks Nationalbank) is somewhat younger, but its history is remarkable for its shifts between public and private ownership. The institution was founded as a private bank in 1736 and, due to insolvency, transformed into a state bank in Some interesting changes took place in the second decade of the nineteenth century. Subsequent to Denmark s finances ruin because of the Napoleonic wars, the old state bank was declared bankrupt in 1813 and replaced by a new state bank, the Rigsbank. Since it had no gold or silver reserves, the Rigsbank supported its issue of bank notes by a rent charge on all real estate in Denmark. In 1818, the state bank was transformed into the privately owned Nationalbank, as the large property holders received shares in the bank in exchange for the rent charge. This privatization of the central monetary institution was reversed in 1936, when the Nationalbank was proclaimed to be a self-owning public institution and the government and parliament were given greater insight into its affairs.

6 Banking in Scandinavia Commercial banks or other private banks emerged in Sweden, Denmark, Norway and Finland only some time after the central banks had been established. The evolution of banking in Scandinavia followed a top-down approach This approach was in contrast to continental Europe and Britain, where commercial banking had developed long before its cyclical instability prompted governments to bring the monetary system under the control of central banks. Even though its commercial banks were latecomers, Sweden has come to be an extreme case of a bank-dominated economy. By the mid-1980s, the two biggest commercial banks held strategic shares in most of the major non-financial companies, of which a large number was ranked among the top 1,000 multinationals in the world. The (mostly social-democratic) Swedish governments supported this concentration of capital and power as it helped them to centralize economic decisions and to carry out their export-oriented growth strategy.

7 Banking in Scandinavia In the other three Scandinavian economies, small and medium-sized companies remained economically and politically predominant, with the exception of the one or two big conglomerates. In all four countries, the financial systems were nevertheless dominated by relatively large domestic banks that were protected from the competition of foreign banks, but at the same time subject to extensive regulation and exchange controls. This changed in the mid-1980s when a wave of deregulatory measures eliminated credit and interest restrictions, at the same time as Northern Europe was opened for cross-border capital flows.

8 Deregulation New markets were set up for a broad range of financial assets. The opening of the markets created a credit boom, a rise in inflation rates, and speculative bubbles in property and equity markets that were supported by huge capital inflows. However, most of the export markets of the Scandinavian industries went into a recession around 1990, while the German Bundesbank began to fight the inflationary impulses of the exceptional reunification boom in Germany. As a result, real interest rates in Scandinavia quickly rose to unprecedented levels. The speculative bubbles burst and produced a wave of bankruptcies, which led to a deep recession and severe banking crises in Sweden, Norway and Finland (and milder problems in Denmark) in the early 1990s. These crises were overcome within a few years, but the landscape had changed very much by the turn of the century. The financial sector in Scandinavia has been transformed by a series of domestic and cross-border mergers and acquisitions, in which some big domestic banks and insurance companies evolved into large financial groupings.

9 Diversity of monetary policy regimes The four countries are currently characterized by a great diversity of exchange rate and monetary policy regimes Finland, Sweden and Denmark are members of the European Union (EU), while Norway is not. Finland is a founding member of the European Monetary Union (EMU), whereas Denmark and Sweden have opted out. Denmark has pegged the exchange rate of its currency to the euro Sweden and Norway leave their exchange rates floating.

10 Diversification of financial systems The diversity between the four countries largely developed after the crisis of the European Monetary System in The process of diversification may be explained by policy responses to the deregulatory transformation of the financial systems. In particular, it was the result of the deep recession and the banking crises. However, it is an open argument how far the respective choices of the exchange rate regime have affected the structures of the financial systems in Scandinavia.

11 The Swedish central bank The Riksbank, the centrall bank of Sweden, obtained full independence by law in its operations to keep the value of money stable only in In addition to its responsibility for monetary policy, the Riksbank also has the tasks of promoting a secure and efficient system of payments and safeguarding the stability of the financial system as a whole. Instead, the responsibility for the soundness of individual financial institutions rests with the Financial Supervisory Authority (Finansinspektionen). The Riksbank is managed by an executive board of six full-time members, who are appointed by the general council for six-year terms. The executive board makes all monetary policy decisions, and its members are forbidden to seek or take instructions from the government or any other institution. For transparency, the minutes of the meetings of the executive board are published very shortly afterwards.

12 The Swedish central bank Apart from selecting the members of the executive board, the general council has a controlling function. Its 11 members are recruited from the ranks of the members of parliament. In its conduct of monetary policy, the Riksbank aims at controlling the market level of short-term interest rates. The main instrument used for this purpose is the repo rate, the interest rate on the weekly repurchase agreements by which the banks borrow from and deposit money in the central bank. By raising the repo rate, the Riksbank signals its intent to curb inflationary expectations. By lowering the repo rate, it signals its willingness to support an expansion of lending and investment.

13 The Swedish banking system In December 2015, there were a total of 116 banks established in Sweden. These comprised 39 limited liability banks, 28 foreign-owned branches and subsidiaries, 47 savings banks, and two co-operative banks. Sweden has, like Germany, a tradition of universal banking. Most Swedish banks offer a comprehensive range of services in retail, wholesale and investment banking. The most remarkable feature of the Swedish banking system is the dominant position of four big banks, which account for nearly 72% of the balance sheet totals of all 116 banks in the country. However, their share in the balance sheet total of all banks has been decreasing in last decade (in 2002 it was about 85%). Two of the Big Four, SEB and Handelsbanken, are old commercial banks with a long tradition of ownership and close management ties with industrial companies. The other two, Nordea and Swedbank, are newcomers with old roots in other segments of the banking business.

14 The Swedish banking system

15 The big four banks in Sweden The SEB (Skandinaviska Enskilda Banken) is the base of the Wallenberg dynasty. This family has presided over Scandinavia s biggest industrial empire for most of the twentieth century and continues to exert its influence over a large sphere of companies by way of foundations, strategic shareholding and directorates Among the major Swedish multinationals under the influence of the Wallenbergs there are Electrolux and Ericsson. The sphere of influence in the non-financial sector of Handelsbanken, the other old commercial bank, is not quite as large. Nordea Bank Sweden, formerly Nordbanken, emerged as a half-privatized company from the state-owned postal bank in the mid-1980s, when Swedish credit markets were deregulated. In the general race for market shares that followed the opening of the markets, Nordbanken increased its corporate lending aggressively. Between 1990 and 1992 it suffered such great credit losses that the government had to acquire all privately owned shares and restore the capital base.

16 The big four banks in Sweden In the mid-1990s Nordbanken was partly privatized again. Since then it has expanded rapidly in the Scandinavian banking markets and changed into Nordea, a large trans-nordic financial services group and one of the first Nordic companies to be registered under the legal form of Societas Europeae Swedbank was founded as FöreningsSparbanken in 1997, when Föreningsbanken, the central institution of the agricultural credit unions, merged with Sparbanken, the largest of the savings banks. Sparbanken was itself a product of mergers of a number of savings banks, some of which had also been in great trouble during the banking crisis of the early 1990s. Traditionally, SEB and Handelsbanken have dominated the market segments of wholesale and investment banking, whereas Nordbanken and Swedbank have held stronger positions in retail banking. The restructuring of Scandinavian banking has greatly diminished these differences.

17 The Danish central bank Danmarks Nationalbank, the Bank of Denmark, has enjoyed independence from the government since However, it is not autonomous in its conduct of monetary policy. Denmark has pursued a fixed exchange rate policy vis-à-vis the Deutschmark since 1982 and the euro since Until 1998, its policy measures were designed to shadow the movements of the German currency. Since the start of the European Monetary Union they have to match the policy of the European Central Bank. Like other central banks, the Nationalbank is also a banker to the banks and to the government. The responsibility for the stability of the financial sector is divided between the Nationalbank, as the guardian of the system, and a separate supervisory authority (Finanstilsynet) that monitors the soundness of individual financial institutions.

18 The Danish central bank The Nationalbank is managed by a board of three governors, who are appointed by the board of directors for unlimited tenure. The board of directors has 25 members, out of whom eight are elected by the parliament, two are appointed by the Minister of Economic Affairs and the other 15 members are elected by the board of directors with a view to involving the business community. A seven-member committee of directors provides a link between the board of governors and the board of directors, without a strict definition of its tasks. The power to decide about the formulation and measures of monetary policy (which, however, have to conform to the exchange rate target) rests entirely with the board of governors. In its conduct of monetary policy, the Nationalbank mainly relies on repurchase agreements, but it still uses the discount rate for signaling its assessment of the market conditions.

19 The Danish banking system The Danish market for banking services is nearly as concentrated as in Sweden, even though it is characterized by a relatively large number of small banks. The five largest banks accounted for 82% of the balance sheet totals of all 113 banks in the country. The market shares of the biggest two, Danske Bank and Nordea Denmark (formerly Unidanmark), were 36% and 23% respectively. Traditionally, mortgage institutions have been strong in the Danish financial sector. In recent years, the biggest banks and mortgage institutions have been penetrating each others markets.

20 The Norwegian central bank Norges Bank, the Bank of Norway, has for a long time been considered to be among the least independent banks. The government and the parliament still have a greater influence on the formulation of the guidelines for monetary policy than elsewhere. But since 2001, Norges Bank has been more independent in pursuing the prescribed target of maintaining inflation in the range of 2.5 per cent In Norway the tasks of supervising the financial system are divided between the central bank and a separate authority (Kredittilsynet). In addition to the usual activities of central banks, Norges Bank manages the Government Petroleum Fund in which a large portion of Norway s revenues from oil and gas production is saved and invested in foreign equities and bonds.

21 The Norwegian central bank Norges Bank is managed by an executive board whose seven members are all appointed by the King. A supervisory council of 15 members, all elected by the parliament, is responsible for ensuring that the rules and guidelines for the bank s activities are observed. In its conduct of monetary policy, Norges Bank has come to rely on repurchase agreements as the main instrument for the liquidity supply. However, as the Norwegian banks tend to have a structural surplus position visàvis the central bank, the sight deposit rate is considered to be the key rate. Furthermore, Norges Bank intervenes frequently in the market, because the government s working account is in the bank. The liquidity position of banks is thus subject to rapid changes, which make it necessary to supply or withdraw liquidity at irregular and short intervals.

22 The Norwegian banking system The Norwegian banking sector is characterized by a relatively strong position of savings and union banks. While the clear division between this segment and the commercial banks has largely vanished in the other Scandinavian countries, it is still perceptible in Norway. Out of the 150 banks supervised by Kredittilsynet, 124 were savings and union banks, mostly small institutes of local character. The segment is dominated by the SpareBank 1 group, with a market share of 12% in the whole banking market. After the acquisition of the Union Bank of Norway in 2003, Den norske Bank (DnB NOR) is now by far the biggest commercial bank in the country, with a market share of 40%. The third big bank is Nordea Norway, the former K-Bank (Christiania Bank og Kreditkasse), with a market share of 13%. DnB and K-Bank suffered heavy losses in the banking crisis of the early 1990s and had to be rescued by government funding. They recovered quickly, but the majority of their shares remained in the hands of the government funds at least until 2000, when K-Bank was sold off to Nordea. The big banks in Norway are comparatively small by Scandinavian standards.

23 The Finnish central bank Finland is one of the 11 founding members of the European Monetary Union. Suomen Pankki, the Bank of Finland, is thus a member of the Eurosystem. It participates in the implementation of the Eurosystem s single monetary policy which is conducted by the European Central Bank. Banks and other financial institutions in Finland are supervised by Financial Supervision (Rahoitustarkastus), which is located at the Bank of Finland, but operates as a legally independent authority.

24 The Finnish banking system Among the Nordic countries, Finland has the largest number of banks and, at the same time, the highest degree of concentration in the banking sector. More than 300 banks were operating in the country. However, the Finnish commercial banks consists of only 14 companies and groups. Most of Finnish banks are small savings banks and local union banks. In 2014, there were 5,641 branches of cooperative banks. The three biggest banks account for around 90% of the balance sheet total of all Finnish banks. Roughly three-quarters of the Finnish banking market is made up by Nordea Finland, formerly known as Merita. Like various other big banks in Scandinavia, Merita was an indirect product of the banking crisis of the early 1990s. The OP Bank Group, a consortium of 243 union banks, has a market share of 27%. The smallest among the Big Three is Sampo with a market share of 3%. It was created by a merger of the two largest commercial banks in the mid-1990s, after extensive rescue operations by the government and the central bank. The Finnish Savings Banks Group consists of 40 savings banks.

25 Other Scandinavian market financial services The firms that operate in other market segments of financial services in Scandinavia are mortgage institutions, other special credit institutions (including state lending institutions), investment companies, mutual funds, insurance corporations and pension funds. In terms of the balance sheet total, the biggest institutional segment of finacnial intermediation, the banking sector, is followed by mortgage institutions and insurance companies. Most of these institutions do not differ very much from their European counterparts. However, nearly all private non-bank intermediaries in Scandinavia are closely connected with, or direct subsidiaries of, domestic banks. They form the integrative all-finance or bancassurance approach of Scandinavian banks.

26 Structures of lending and asset holding In a system of universal banking, the banks aggregate portfolio is naturally more diversified than the portfolios of the other, more specialized groups of institutions. The banks, despite their dominant position, are not necessarily the biggest lenders in credit markets or investors in bond and equity markets. Mortgage institutions account for a greater volume of direct lending to the nonfinancial sector. Insurance companies and pension funds hold more bonds and shares than the banks. The prominent role of mortgage institutions reflects the high degree of owneroccupied housing in Sweden. Real property constitutes the greatest item among households net assets in the whole of Scandinavia. Yet the systems of finance for housing differ a lot between the countries.

27 Mortgage institutions In Denmark, special institutions have traditionally played a far greater role in the mortgage market than banks. Mortgage institutions lend roughly the same amount in Denmark and in Sweden, but the Danish population is only 60% of its Swedish counterpart. In contrast, the segment of mortgage banking is much smaller in Norway and smallest in Finland where housing is largely financed by way of bank loans. These differences are largely due to two factors: 1. mortgage banking has enjoyed greater privileges and subsidies in Denmark than in Norway and Finland. 2. the bond markets of the two northernmost Scandinavian countries were, for a long time, far too small to provide the means for refinancing mortgage loans. In Denmark, on the other hand, mortgage institutions often intermediate between bond markets and firms. Many companies prefer to borrow from them rather than financing their investments through direct bond issues.

28 Effects on the transmission mechanisms The differences in housing finance are of some importance for the transmission of monetary policy. The longer the periods of fixed interest in loan contracts, the lower is the immediate impact of changes in the central bank s lending rate on consumer spending and on overall economic activity. The financial structure in Denmark is dominated by long-term borrowing at fixed rates via mortgage institutions. Lending and borrowing at floating (or short-term adjustable) interest rates, instead, is very common in Norway and Finland. In Sweden, the share of fixed interest contracts is about 50%, but the average duration of fixed interest periods has varied frequently and conversely with the market level of interest rates in recent years. Monetary policy in Denmark works less directly and with longer lags than equivalent measures in Sweden, Norway and Finland.

29 Structures of lending and asset holding The liabilities of the financial sector are to a large extent financial assets of the household sector. There are further significant differences in portfolio structure between the national systems of financial intermediation. Sweden has frequently been ranked as the country with the world s highest ratios of households shareholding and of shareholders among the population. However, the wide distribution of shares has been supported by various political measures. Furthermore, large fraction of the investment funds, through which Swedish households indirectly hold shares, are subsidiaries of domestic banks. This gives the banks another channel of influence on the decision making of the fund managers. In Denmark and Norway, by far the largest part of financial assets is held in the form of bank deposits and insurance claims. The differences in shareholding could lead to differences in the transmission of monetary policy between the Nordic countries. Indeed, share values are quite sensitive to changes in the market level of interest rates and value gains and losses frequently have a wealth effect on borrowing and consumer spending.

30 Pension funds All the pension systems in Northern Europe rest on three pillars: 1. a general public pension; 2. supplementary occupational pension schemes; 3. individual private pension saving. The first pillar has often been regarded as the main element of the Scandinavian model : a pension system that follows the principle that all citizens have the right to the same pension. This public pension is independent of previous contributions and it is paid from general tax revenues. However, what was meant to be an equal pension for all has become a minimum pension over the last three decades.

31 Pension funds The second pillar has therefore enormously gained in importance in all four countries. Mandatory schemes have developed along with voluntary schemes at trade union and firm levels. The supplementary pensions in the mandatory schemes depend on previous contributions from payroll taxes and on the salary incomes of the last working years before retirement. These schemes are partially prefunded. The contributions of the wage earners are paid into National Pension Funds which invest the money in the financial markets. Finland is an exception, because the pension funds are managed by private insurance companies.

32 Pension funds The National Pension Funds are large investors in the financial markets. The Swedish AP-fonden and its Danish counterpart ATP account for 6% of the balance sheet totals of financial institutions in their countries. No separate figures were available for Norway and Finland. However, one of the objectives of the Norwegian Government Petroleum Fund is to meet the financial challenge of paying for an ageing population. The balance sheet total of the Petroleum Fund corresponds to one-tenth of the total of all other financial institutions. In addition to the occupational pension schemes, a number of other pension funds exist in all four countries. So far, they play only a minor role in the capital markets and for pensioners incomes.

33 Market expansion and banking crises Before the 1980s one could hardly speak of financial markets in Scandinavia, at least not in terms of transaction volumes in the money, bond or equity markets. The financial systems in all four countries were clearly centred on bank lending, strictly segmented and regulated by interest and credit ceilings, portfolio restrictions and exchange controls. Apart from small interbank markets, there were no money markets. Bond markets were largely confined to primary markets for issues of the governments and the mortgage institutions. Investors were almost exclusively domestic insurance companies and pension funds, which were legally obliged to hold certain shares of government bonds in their portfolios. The equity markets were quiet places, as the open trading of shares was rather marginal. Most of the shares were continuously held for purposes of strategic control or as long-term investments in fund portfolios. As in many other countries, this changed with financial market deregulation and integration in the 1980s.

34 Market expansion Many Scandinavian companies had begun to circumvent the exchange controls or to use grey credit markets, when prices, interest rates and exchange rates became increasingly volatile in the 1970s. As the governments and central banks noticed that quantitative regulation no longer ensured control of activities in the financial sector: 1. they abolished controls over banks lending volumes and interest rates 2. they created open money markets and bond markets as arenas for their use of interest rate policy. 3. they dismantled other portfolio restrictions and exchange controls, so that equity markets became increasingly attractive.

35 Deregulation Deregulation did not come everywhere at the same time. In Denmark, the process had already started around 1975, since the country had joined the European Economic Community. In Sweden and Norway, the biggest changes came with the creation of fullyfledged money and bond markets in the early 1980s. In Finland functioning secondary markets for bonds and equities appeared only at the beginning of the 1990s. The years around 1985 nevertheless mark a period of extraordinary credit expansion in all four countries, which clearly had its root in the deregulation of the financial sectors. Unfettered competition in the loan markets led to a sharp increase in bank lending to investments in commercial and residential property as well as equity. A debt asset price cycle developed that interacted with accelerating inflation.

36 Asset price inflation Competition kept nominal interest rates at a low level, and real interest rates were even lower due to inflation. Borrowed funds helped to fuel the rise in asset prices which, in turn, helped to increase the borrowing capacity of firms and households. The banks pushed on in their race for market shares and profits. Between 1982 and 1989, house prices in Sweden rose by 50%, commercial property prices by almost 200%, and equity prices by almost 400%. Similar developments took place in Norway and Finland. In Denmark, the asset price inflation was considerably lower, since the market expansion was: 1. stretched over a longer time; 2. more restricted by the relatively high interest rates that Danmarks Nationalbank had to set in order to meet its exchange rate targets within the European Monetary System.

37 Banking crises The debt asset price cycles of Sweden, Norway and Finland proved to be unsustainable when real interest rates surged to unprecented levels around A worldwide recession, the breakdown of trade with the Soviet Union and the weakened confidence in the fixed exchange rates led the central banks of the three countries to pursue strongly disinflationary policies. The speculative bubbles in the property and equity markets burst. This produced heavy credit losses, which brought many of the largest banks of Scandinavia to the verge of collapse. Finland experienced severe banking crises that quickly proved to be too strong for ordinary lending of last resort by the central banks.

38 Banking rescue operations The central governments had to intervene, but the type and costs of their rescue operations differed considerably between the three countries. In Norway and Finland, the rescue operations were largely carried out with resources from the central banks and government funds. In Sweden the central government alone was involved. The Swedish solution of the problem was quite spectacular and much debated. Between autumn 1992 and the end of 1993, the central government provided unlimited state guarantees for all commitments of banking institutions toward creditors and depositors. Prior to this, the government had injected large funds into the three banks whose equity capital was wiped out by the credit losses. Nordbanken, which had been a state-majority-owned bank, and Gota Bank were completely taken over by the state and stripped of their bigger problem assets which were transferred into two newly created, state-owned bad banks, Securum and Retriva. Even all the other big banks seized the chance to recycle their bad assets through such taxand-cost-saving special institutions.

39 Costs of rescue operations The immediate costs of these rescue operations, in terms of percentage of GDP, were considerable.

40 Costs of rescue operations Since they had to be borne by the taxpayer and since the banks shareholders were treated rather generously, there was some debate about moral hazard problems. Moreover, it was argued that the bail-out through state guarantees and bad banks tends to undermine incentives to cost-efficiency in the banking business and that it has placed the more prudent banks at a competitive disadvantage. Technically, the handling of the problem assets has been quite successful. When Securum, the biggest bad bank, was liquidated in 1997, a large share of the problem assets and institutions were sold off at reasonable prices, Nearly half of the state s immediate costs of the rescue operations had been retrieved. However, the bad banks were accused of liquidating too many companies and jobs on their way. Nevertheless, the total costs of the banking crisis would have been much higher for the Swedish economy if the state had not bailed out the banks.

41 References Bain K., Howells P., The Economics of Money, Banking and Finance. A European Text, Pearson Education, 2008, ch. 7