Stefan Ingves: Financial crises in an international perspective
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank, at the Danish Financial Supervisory
Authority, Copenhagen, 12 September 2006.
* * *
Thank you for inviting me here today. It is easy to forget what a financial crisis entails, now that a
number of years have passed since we last experienced one and it is therefore important that we
remind ourselves. Although we cannot yet see any immediate threats, we must look ahead to prevent
potential crises.
During my twenty minutes or so today I intend to talk about the following:
•
the fact that most of the various crises in different countries during the 1980s and 1990s
have had a number of common causes,
•
the fact that it is important to invest in preventing and managing crises,
• the fact that risks and potential vulnerabilities in the financial system are now changing
rapidly as the differences between banks and other financial institutions decline and
crossborder integration intensifies,
•
the fact that the cooperation between authorities within and between countries must be
developed further, both with regard to regular monitoring and crisis management. In
particular, it is necessary to discuss how the responsibilities and costs should be divided up
in the event of a crisis.
Many of the experiences I describe refer to crises and countries outside of Scandinavia, even outside
of Europe, which does not prevent them from being relevant to our discussion. However, I will in some
cases refer directly to the situation in the Nordic countries, with regard to the advantages and also the
challenges presented by the far-reaching integration of our financial systems.
Introduction
An IMF study published a few years ago indicated around 130 financial crises in a fifteen-year period
during the 1980s and 1990s; some countries were afflicted more than once. As we all know, we have
also had our share of crises in the Nordic countries. Denmark has managed better than the other
countries - you had no acute systemic crisis, but a few incidents where individual banks suffered
major losses. Many international studies point to the large costs linked to crises - costs to individuals,
companies and society as a whole, both direct financial costs and indirect social costs. For example,
the crisis in Indonesia cost around 60 per cent of the country's annual GDP. A World Bank study
shows that poverty combating in this country was reversed by twenty years. The conclusion is, of
course, that it is very important to prevent crises and to manage crises in a way that minimises
damage.
In my earlier work at the IMF, I was directly involved in crisis management in several countries, but
also in the prevention work. My assessment is that many countries have made considerable efforts in
recent years to reduce the vulnerability of their financial systems. At the same time, much remains to
be done, not least to meet the constant changes in the financial world. What gives me hope that this
will really happen is that international pressure has increased - countries wishing to become full
members of the global financial system are forced to at least live up to an international minimum
standard.
So which are the factors that lead to crises and how should they be dealt with?
Experiences of crises in a large number of countries around the world
It is possible to divide crises into those that only affect the financial sector and those where the
financial sector forms part of - and aggravates - a broader economic crisis, as was the case in
Sweden in the 1990s. The broader economic crises are usually based on untenable macroeconomic
imbalances. Large deficits in central government finances or in the current account, unrealistic
exchange rates or similar. One experience that Sweden shares with many other countries is that large
and essentially desirable deregulation processes and other policy changes may lead to crises if they
are not managed properly. The broader crises are more comprehensive and more difficult to resolve,
partly because the possible solutions are not as clear-cut and entail weighing different social interests
against one another. However, even the crises that specifically affect the financial sector, usually
primarily the banks, often have their roots in weaknesses outside of the sector. These crises often
result from a combination of "bad policies, bad banking and bad luck".
According to the studies made by, for instance IMF employees, bank crises have often been due to
one or a combination of these factors:
• A lack of competence in the banks, which has combined with weak regulation and
supervision to lay a foundation for potential problems. This could be a question of
inadequate credit granting policies, exaggerated confidence in loan collateral, an inability to
detect risk concentrations.
•
Criminal abuse of the banks, such as improper actions by owners and other insiders or
"common criminals" such as Nick Leeson at Barings.
•
Malpractice by the authorities towards the banks, for instance non-commercially directed
lending.
•
Many countries also suffer from their supervisory authorities lacking sufficient independence.
The government becomes involved in the authority's operational decisions and prevents the
necessary measures from being implemented against problem banks.
• Weaknesses in structural factors, such as laws and courts. There may also be flaws in the
financial security net, for instance deposit guarantees or rules for closing down banks, which
mean that the authorities postpone dealing with problems that have arisen for as long as
possible.
The crises can be aggravated and the solutions can become more severe and more expensive in
some cases, for instance if the central government itself has poor finances or is bankrupt (Indonesia
1998). It then lacks the capacity to intervene with sufficient financial support measures to manage the
crisis. If the country is strongly dollarised or has a currency board (Argentina 2001) or another form of
fixed exchange rate regime, there is no possibility to take certain measures, such as supply the
economy with a large amount of liquidity. Finally, I have seen that in the cases where the financial
sector is large in relation to the rest of the economy (Thailand 1997), the negative contagion effects to
society as a whole are much greater.
How can one prevent financial crises? In my experience, much can be achieved if the authorities and
the financial participants together draw up effective preventive measures and plans for good crisis
management. One clear and positive conclusion from the crises in the past twenty years is that good
crisis management can save large amounts of money and reduce disruptions to society. On the other
hand, it has been demonstrated that bad crisis management aggravates crises, partly by spreading
uncertainty among the general public and the financial market agents.
Good crisis management involves creating good laws, regulations and supervision. I have seen
deficiencies in these fields in many countries. The legal framework may be insufficient, including the
external conditions for good supervision, such as poor auditing and accounting. In some countries it is
even possible to question whether a rule of law prevails there; that is to say, whether the laws are the
ultimate guiding principle as to how the country is governed.
Managing a crisis also requires laws and regulations that enable a problem institution to be closed
down quickly or managed in some other way. Sometimes it is necessary to take measures very
quickly, perhaps even the same day. It is not possible to wait for the usual court process to be
completed. To avoid this leading to any form of malpractice, the injured party should have the
opportunity to obtain redress and damages afterwards. We had this kind of a law in Sweden during our
financial crisis.
Another question is when a court should be allowed to stop important authority decisions intended to
deal with acute bank problems, such as closing a problem bank. When a bank needs to be closed, a
difficult balance arises, between the owners' interests and the savers' interest, which are both
safeguarded in law. One very current example of this dilemma in Sweden is the case of Custodia.
Both the country administrative court and Finansinspektionen (the Swedish financial supervisory
authority) have made their assessments on the basis of what they should take into account, that is to
say the customers' interests and the company and owners' interests respectively. However, I feel that
it is very unsatisfactory that we in Sweden do not have a clear legal framework that can manage this
type of situation and I assume that these difficulties will quickly be repaired.
Crisis prevention also includes creating sufficiently strong public authorities. Unfortunately, one can
see that the authorities in many countries have insufficient resources, independence and competence
to match the often financially strong and rich in expertise financial institutions, whose owners can
moreover all too easily gain the support of politicians against the supervisory authority's demands for
measures. This is of course a more serious weakness in a problem situation where a lack of
measures, insufficient measures or delayed measures can aggravate the crisis. Another problem,
although fortunately one we do not have in the Nordic countries, is harassment of the management
and personnel within the public authorities for the purpose of reducing their ability and willingness to
take supervisory measures against wrongdoing banks.
In addition, it is important to establish clear roles and areas of responsibility between public authorities
within the same country, between authorities in different countries and also between the authorities
and the financial institutions. I have seen that in some countries it is unclear which authority makes the
decisions, or which authority has the power to decide on a particular issue, because the law is unclear
or because it is not followed in practice. This lack of clarity is accentuated in a crisis situation and
hampers crisis management. This can be expressed in different ways, such as poor coordination
between the authorities with regard to public statements and decisions or territorial conflicts arising
and special interests being favoured over general solutions.
If one wishes to detect problems in good time, before they develop into a crisis, it is important that the
public authorities within a country and those in different countries can coordinate and exchange
information. There have been large inadequacies in this field in previous crises. This can to some
extent be blamed on confidentiality regulations, and the relevance of these may be questioned during
a crisis, but in all honesty it can also be blamed in many cases on the authorities having insufficient
interest in collaborating.
Tendencies in the financial sector
The financial sector is subject to rapid development. The borders between different financial activities
are being eroded. Banks are selling insurance-like products and insurance companies are selling
banking products. In some cases financial conglomerations are being established. Moreover, the trade
in financial instruments has developed to such an extent that the risks are spread to a greater number
of agents than before and also spread outside of the banks and insurance companies.
Another development is the cross-border integration, particularly in the Nordic countries. Danish banks
have established themselves in Sweden and Swedish banks in Denmark. Integration as such is a
positive development, for several reasons and not least to increase economic growth. The Riksbank
therefore supports measures, for instance within the EU, that lead to greater integration. It is therefore
important that the authorities manage the risks that integration might entail to avoid setbacks. In
addition to the complications that follow on from an institution being established in several countries,
supervision and risk management are made more difficult by the banking group sometimes choosing
to manage the risks on a functional basis and not in accordance with the bank's forma organisation.
For example, a bank with operations in several countries can choose to locate all of its credit
management to one country and its liquidity management to another country.
In general, this development strengthens financial stability. The capacity to identify, manage and
reduce risks has increased. The institutions' cross-border operations make them less dependent on
how the economy of an individual country develops. However, at the same time a number of new
possible problems arise, which must be prevented and managed by institutions and authorities. Risks
and vulnerabilities may fall between different authorities' or countries' fields of responsibility and
thereby may go unnoticed. Or, if they are noticed, territorial conflicts may arise, making it more difficult
to implement the measures needed. It may also be unclear where the risks will end up. Bank
supervision can ensure that the banks have sold certain risks, but it is not clear whether the buyers
have the knowledge and financial strength to manage these risks. In the worst case scenario, the risk
will return to the bank in a loss situation.
The development I have described must be met with increased harmonisation of regulations and
supervision, both between sectors and between countries. This has already been achieved to some
extent within the EU, but it needs to be achieved on a global basis. Moreover, the coordination and
exchange of information must be strengthened both in "peacetime" and during crises. Not surprisingly,
I consider it important to implement regional financial stability analyses to detect possible
vulnerabilities; the type of analyses now being made in the IMF-led exercise in the Nordic-Baltic
region. Furthermore, both the institutions and the public authorities must gain greater knowledge of
where the risks end up and what might happen if the ultimate risk-takers suffer problems.
The Nordic countries and the Baltic countries
Financial integration has come a long way in the Nordic and Baltic countries. There is a close
collaboration between the central banks and financial supervisory authorities in the Nordic countries.
We have agreements on consultation in the event of crises and we hold joint crisis exercises. As
Swedish banks play an important role in the Baltic countries, discussions are under way on the signing
of a consultation agreement between the Swedish and Baltic authorities. One important weakness that
remains is the unclear distribution of the financial costs between countries in the event of a crisis. A
closely-linked but also unsolved issue is which country's assessment of the situation will prevail and
who may decide on measures such as closing a bank. Are the Danish taxpayers prepared to help pay
to save Nordea's operations in a crisis or do you see it as a problem for the Swedes alone? The
question can be reversed, to ask how we Swedes would regard a crisis in Danske Bank.
These issues are not unique to our countries; they apply to all countries and therefore require
widescale international management. This is a difficult but important issue to discuss - before the next
crisis occurs. One means of making this issue more concrete could be to hold a new Nordic crisis
exercise based on the conditions in a real bank. It would be necessary in this type of exercise to take a
stand on the specific case, which in turn might make it easy to continue a general discussion.
Conclusion
The crises during the 1980s and 1990s led to many important measures being taken:
A number of international standards were adopted to create global minimum standards for regulation
and supervision, for instance the Basel Committee's Core Principles for effective banking supervision.
The tasks of the IMF and the World Bank were increased to systematically identifying vulnerabilities in
countries' financial sectors, proposing measures to remedy them and giving technical assistance. The
private agents in the financial market have also taken initiatives to reduce risks. They have, for
instance, established the CLS Bank to reduce risks in foreign exchange trading.
The banks and public authorities currently have a much better grasp of the risks in the financial sector
and how these can be managed and reduced - this is probably part of the explanation why we have
seen a clear decline in the number of bank crises in recent years. At the same time, the developments
I have outlined above, including the creation of large financial groups and payment centres, lead to
new types of risk that need to be managed. The consolidation on the part of the market must therefore
be met with increased coordination on the part of regulations and public authorities.
We do not need more regulation and supervision; the challenge is that regulation and supervision
must always be adapted to development and, as now, aimed at detecting and remedying the most
critical vulnerabilities in the financial system. This sounds obvious, but it is not so easy to achieve in
practice. Commercial developments are rapid, while it always takes a little longer to adapt laws and
public authorities, particularly if regulation and supervision are at the same time to be harmonised
across national borders. From my work in various international forums, I know that the Danish
authorities in general share my views on the importance of the issues I have mentioned today and I
look forward to continued cooperation with you in various ways to prevent financial crises and thus
avoid having to manage them together.