The Nordic crisis of 1992 refers to the series of bank runs and currency crisis that shook Finland, Sweden as well as Norway in the early 1990’s. This was the first major national banking crisis since the 1930’s (if wars are not taken into account). Thus, an important belief that the fractional reserve banking system has been stabilized all over the world, has been challenged and shaken to the core. In this article, we will understand the factors that led to the crisis as well as the repercussions of the crisis.
The period immediately preceding the crisis saw an unprecedented credit boom in the Nordic region. This was because earlier there was limited credit available in these countries. However, under the new system, credit was easily available. Hence, there was no need for the credit to be rationed. This caused a boom in the rate at which borrowing was happening in the Nordic region.
To make matters worse, the tax authorities of Sweden, Finland as well as Norway created laws which favoured borrowing money. Liberal tax breaks were given to people who borrowed money regardless of whether the money is borrowed for productive purposes or not!
In most cases, the interest rate for borrowing money was negative after tax breaks were taken into account. Thus people started believing that borrowing money is like getting a free lunch. As the quantum of borrowing increased beyond acceptable limits, macroeconomic problems began to develop.
Over Valued Collateral
The banks in the Nordic region followed sound business practices. They would offer credit against collateral. Most of the times, the collateral was of good quality. There were real estate or blue chip stocks backing the loan. However, the increased expansion of credit had overheated the economy. As a result, the money supply had risen dramatically taking up the price of everything else. The central banks and other regulatory agencies conducted minimal supervision and ended up aggravating the crisis through their inaction.
As a result, even after the sound business practices by banks, they ended up loaning money against highly overvalued collateral. This fact would come back to haunt them later.
The crisis impacted the region in a big way because of a series of negative events that happened simultaneously. For instance, Norway’s economy is largely dependent on oil. Hence, when there was an oil shock in the early 1990’s, the economy faced distress and as a result, the overheated asset prices dropped rapidly. Consumer confidence took a plunge and credit started contracting much faster than it had expanded. Norway’s central bank i.e. the Norges bank found itself in a soup as a result of the bank runs which were rampant in those days.
The Swedish economy also faced a currency crisis because of an attack by speculators during those days. Sweden’s largest savings bank i.e. the Forsta Sparbanken suffered a bank run as people lost confidence in their currency.
Similarly, the Finnish economy also faced significant difficulties as the former Soviet Union disintegrated. The Finnish economy was largely integrated with Soviet. Therefore, as its biggest trading partner went into turmoil so did the Finnish economy.
Multiple negative events shook the foundation of different Nordic countries making it impossible for them to support each other during the crisis, thereby aggravating the crisis even further.
The central banks of the three nations had to act in tandem. In fact, they even had to use the support of other developed nations to get rid of this crisis. The public’s confidence in the fractional reserve banking system was in jeopardy and therefore the governments and the central bankers of the Nordic region faced no shortage of sympathizers.
Firstly, there was a massive $8 billion bailout by each of the three countries which was offered to their banks. At the root, the Nordic crisis was a bank run. Thus, to stop the bank run the government started to recapitalize the banks and it did so in a very public manner. The capital was offered to banks in the form of shares or notes. Most of the banks in the Nordic region accepted this capital and resumed business as usual. After some time, the depositor confidence was restored, and the bank runs were successfully managed.
To top it up, the Nordic governments vociferously proclaimed that they would guarantee the deposits of the entire banking system. They extended this guarantee for 6 long years i.e. till 1998. By that time, the Nordic crisis was long gone and banks could function as usual without any government intervention.
The Nordic crisis was an important reminder that sudden credit expansion makes economies extremely vulnerable to any external shocks. Given the inherently unstable nature of the fractional reserve banking system, credit must be tightly monitored.