## _cr13274

## Source details

**Canonical URL:** [_cr13274](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13274.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13274.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13274.pdf.json)

---

### Overview and purpose
- Examines regional strengths and challenges of the four continental Nordic countries—Denmark, Finland, Norway and Sweden (henceforth the Nordic-4).
- Aim: identify common challenges and shared risk, and discuss implications for national policies and benefits from further regional cooperation.
- The Nordic-4 share the “Nordic model”: growth-enhancing trade and financial openness, stable public finances, cooperative labor markets, and equitable income distribution.

### Recent performance and structural strengths
- Recent performance:
  - Suffered severe downturns in 2009 but outperformed other advanced economies in the recovery and emerged as safe havens during the euro area sovereign crisis.
  - Despite strengths, the region faces large cross-border banks, highly indebted households, and weak global growth which together raise vulnerability to cross-border shock transmission.
- Structural strengths:
  - Significant investment in R&D, education, infrastructure; active labor market policies; consistent macroeconomic policy frameworks.
  - Large—but fully-funded—public sector support mechanisms; Nordic-4 remained in the top 15 globally competitive economies.
  - Prudent public finances and fiscal rules contained gross public debt and built fiscal buffers.
  - Robust social safety nets, universal healthcare and education, and tax policies geared toward employment that supported moderated wage pressures, high labor force participation, and low inequality.

### Openness: trade and financial integration
- Trade openness:
  - Total exports and imports of goods stood at over 60 percent of GDP, in 2012, of which 20 percent is intraregional.
- Financial openness and concentration:
  - The six largest banks in the Nordic-4 comprise roughly 90 percent of the total assets of all the region’s publicly-listed banks.
  - Roughly 85 percent of both the credit and deposits of these six banks come from the four Nordic countries.
  - Nordic banks are heavily reliant on wholesale funding; covered bonds increasingly important.
  - Banking sector’s portfolio of private mortgages mirrors high levels of household debt.

### Transmission, spillovers, and safe-haven dynamics
- Transmission:
  - Trade and financial openness make the Nordic-4 susceptible to global and regional shocks; much cyclical variation is driven by external shocks.
  - A structural macro-econometric model covering 35 large economies estimates spillovers from trade channels, financial markets, and commodity prices, accounting for regional comovement.
  - Spillovers into the Nordic economies come predominantly from neighbors within the region and systemic advanced economies; Sweden-originated trade and financial shocks have the largest spillovers to the other Nordic countries.
  - Outward spillovers from the Nordic-4 to the rest of the world are low, except to closely-linked Baltic countries.
- Safe-haven flows and funding implications:
  - Robust fundamentals made the Nordic-4 a destination for safe-haven flows as the euro area crisis peaked.
  - Triple-A credit ratings facilitated safe-haven flows into sovereign and private assets.
  - Banks retained access to wholesale financing at relatively favorable rates; legislative changes in the mid-2000s in Finland, Norway, and Sweden aided this.
  - Denmark: safe-haven flows loosened monetary and financial conditions and led the central bank to set one of its deposit rates at negative levels since July 2012.
  - Norway and Sweden managed exchange rate appreciation through much of the later part of the crisis.
  - Possible “tapering” of U.S. Federal Reserve bond purchases created some volatility in the relatively small Norwegian and Swedish currency markets.
  - Large-scale and excessive reversal of safe-haven capital flows is characterized as a risk rather than a baseline scenario.

### Common vulnerabilities and household sector risks
- Common vulnerabilities:
  - An outsized regional financial sector, high household debt, reliance on domestic and foreign wholesale funding, and constraints on monetary policy for some Nordic-4 imply rapid cross-border transmission of shocks through banks to households and the broader economy.
  - Household net asset positions often mask a mismatch between liquid assets (nonpension and nonhousing) and overall liabilities (debt).
- Housing market patterns and statistics:
  - House prices rose in tandem mid-1990s until 2007; increased by more than 120 percent on average between 1995 and 2007.
  - Since 2007:
    - Real house prices in Norway have continued to increase by more than 10 percent relative to 2007.
    - Prices fell by close to 30 percent in Denmark.
    - In Finland and Sweden, house prices have remained broadly constant.
  - Drivers: Denmark had a construction boom and correction starting in 2006–07; Finland, Norway, and Sweden characterized by supply shortages due to zoning restrictions, construction requirements, and rent control legislation in some countries.
- Household balance sheets and macro sensitivity:
  - Household debt levels well above the average of other advanced economies.
  - With the exception of Finland, household debt has grown rapidly over the last decade, driven by rising house prices and easy access to credit, including mortgages with deferred amortization and high loan-to-value (LTV) ratios.
  - Denmark’s household debt-to-disposable-income ratio is the highest in the OECD.
  - Household assets are higher than gross liabilities, but household assets as a share of disposable income are not as high as in many other advanced economies.
  - Large share of household assets is illiquid (housing wealth, pension accounts).
  - Excluding housing and pension/insurance assets, net liquid assets as a share of disposable income are negative in Denmark and Norway and low in Finland and Sweden.
  - Cross-country econometric work suggests that a 10 percent decline in property prices will:
    - reduce aggregate GDP by as much as 2½ percent,
    - reduce private consumption by as much as 3½ percent,
    - reduce private residential investment by as much as 28½ percent.

### Banking sector structure, funding, and resolution concerns
- Banking-sector size and concentration:
  - Pan-Nordic bank expansion increases spillover risks; cross-border operations can transmit shocks across the region.
  - Example: Nordea — subsidiaries in Finland and Denmark are larger than the Swedish parent.
  - Publicly-listed assets equivalent of up to 400 percent of GDP changes crisis dynamics versus past episodes.
- Capitalization:
  - Regulatory core Tier 1 capital ratios for deposit-taking banks:
    - Denmark: 16.7 percent (latest available data)
    - Finland: 15.5 percent (2013:Q1)
    - Norway: 13.2 percent (2012:Q4)
    - Sweden: 11.3 percent (2012:Q4)
    - All are above the 9 percent minimum set by the European Banking Authority.
- Funding vulnerabilities:
  - Loan-to-deposit (LTD) ratios are almost twice as high as the average of the largest banks elsewhere in the world.
  - Households save largely through pension and mutual funds rather than deposits or mortgage amortization; savings channeled back to banks via institutional investors mostly in the form of longer-term covered bonds.
  - A self-reinforcing cycle developed between credit growth and increasing wholesale funding needs.
  - Reliance on wholesale funding makes banks vulnerable to excessive reversals in safe-haven flows beyond normalization.
- Covered bonds and asset encumbrance:
  - Covered bonds provide low-cost and stable long-term funding and reduce probability of default and risk to taxpayers.
  - Increasing use of covered bonds raises concerns over asset encumbrance and availability of capital for bailing in creditors during resolution.
  - Asset encumbrance can raise loss-given-default as covered bonds reduce capital available to other creditors, who may demand higher returns.
  - Covered bonds reduce assets available to deposit insurance funds, potentially increasing costs to taxpayers in bank defaults.

### Fiscal cost uncertainty from systemic bank failure
- Liquidity costs and eventual losses to the sovereign from a regionally-systemic bank failure are difficult to predict but could be substantial.
- Staff estimates of direct fiscal costs of a potential systemic banking failure (i.e., all six banks) vary substantially by country and by assumptions on which creditors/governments are bailed out.
- Example for Sweden:
  - Fiscal costs range from 90 percent of GDP if all creditors were bailed out and costs were assigned to the home country,
  - to just over 15 percent of GDP if only insured depositors were bailed out and host governments bailed out local depositors.
- Costs for other countries are lower but still quite high and vary substantially depending on assumptions about creditor treatment and government backstops.

### Policy implications — national measures (staff recommendations and observed reforms)
- National reforms under way and observed:
  - Denmark: reducing banks’ dependency on state guarantees; implementing additional capital requirements for systemically important banks.
  - Finland: reducing incentives encouraging debt-financed house purchases by lowering the share of mortgage interest deductible from taxable income.
  - Norway: on track to implement a counter-cyclical capital buffer in mid-2014.
  - Sweden: increased capital and liquidity buffers and introduced a risk-weight floor for mortgages.
  - Denmark and Sweden: securing flexibility to impose higher capital requirements in the context of the Capital Requirements Directive (CRD IV).
- Staff-recommended national measures:
  - Mortgages: Phasing-in minimum amortization requirements (especially in Sweden) and binding LTV ratios (noticeably absent in Finland).
  - Taxes: Phasing out tax advantages for home ownership—including mortgage interest deductibility common in all of the Nordic-4.
  - Capital: Adjust mortgage risk weights to compensate for high household debt and elevated house prices; strengthen capital buffers beyond the EBA 9 percent and Basel III targets.
  - Funding / Liquidity:
    - Maintain adequate liquidity through steps toward the 100 percent liquidity coverage ratio (example: Sweden’s requirement comprises all currencies totaled and also separately for euros and U.S. dollars).
    - Establish a clear schedule for reaching the 100 percent Net Stable Funding Ratio (NSFR) target by 2018.
  - Fiscal buffers: Strong fiscal buffers important to provide capacity to take on additional debt in the event of a large bank resolution and to allow automatic stabilizers to work during volatility transmitted through trade channels.
  - Coordinated fiscal reaction across the Nordic-4 to a large external growth shock could yield significant gains compared with independent reactions (chart period noted 2012–2017 in staff calculations).

### Policy implications — regional cooperation and resolution
- Priority areas for active regional cooperation (staff):
  - Information: Active and continuous information exchange among supervisors and other authorities on the regional dimension of work, building on NBMF and NBSG coordination.
  - Reciprocity: Ensure branches of foreign banks adhere to local regulations and operate under conditions tailored to that market.
  - Macroprudential minima: Jointly-agreed regional minima to prevent regulatory arbitrage and cross-border concentration of risk. Examples:
    - Gradual movement to regional risk weights on mortgage assets at the Basel III floor of 35 percent.
    - Capping and enforcing LTV ratios at 90 percent or less for all new mortgages over the medium term.
- Joint preemptive efforts for regionally-important banks:
  - Strengthen capital and liquidity requirements across the Nordic-4 to reduce probability of a pan-Nordic banking crisis.
  - Agree on allocation of capital and liquidity among national subsidiaries and branches (e.g., convertible capital bonds) and joint plans for regionally-systemic banks chosen on mutually-agreed characteristics.
- Progress and constraints:
  - Pending cooperation agreement for the Nordea Crisis Management Group specifies principles for cross-border resolution, including a group resolution plan updated annually by Nordea’s home authorities with active participation of other jurisdictions.
  - Bank Recovery and Resolution Directive (RRD), once adopted, should confirm national options including government bail-outs or broad private sector bail-ins after a minimum level of losses have been imposed on shareholders and creditors.
  - Authorities differ on feasibility of legally-binding ex ante burden sharing and on applying macroprudential minima at parent company versus country level.

### The Nordics and the Banking Union
- Banking Union (BU) components: Single Supervisory Mechanism (SSM), Single Resolution Mechanism (SRM), and Deposit Guarantee Scheme (DGS).
- Membership implications:
  - Finland: automatic membership of the BU.
  - Norway: precluded from joining by its constitution.
  - Denmark and Sweden: choice to stay outside or join could result in diverse supervisory regimes across the Nordic-4 while up to three countries might fall under the same EU-based resolution framework.
- Potential benefits and concerns:
  - BU membership could smooth regulatory coordination, financial supervision, and cross-border resolution and, with SSM, SRM, DGS and a common fiscal backstop, could help mitigate tail risks.
  - Authorities concerned about adequate representation for non-euro area members and possible mutualization of risk; Banking union membership not possible for non-EU member EFTA states.

### Executive Board assessment and authorities’ views (Press Release No. 13/324 — September 5, 2013)
- Executive Board salient findings:
  - Nordic-4 share strong economic and social institutions, fiscal prudence, and high regional/global openness.
  - Shared vulnerabilities: large, integrated, concentrated banking sectors; high household debt; elevated property prices; close regional trade and financial linkages that can transmit shocks rapidly across countries and to the Baltic economies.
  - National financial reforms and strong fiscal frameworks have created fiscal buffers.
  - Nordic cooperation on financial sector issues exists, but burden-sharing arrangements for systemic bank failures are at an early stage.
- Directors’ endorsed policy recommendations:
  - Reinforce national housing and banking policies to preempt systemic risks from house price corrections and banks’ wholesale funding dependence.
  - Raise risk weights for mortgages to ensure adequate capital buffers while maintaining sufficient liquidity.
  - Maintain strong fiscal buffers to guard against costly tail events in the banking sector.
  - Restrict availability of interest-only mortgages.
  - Gradually phase out preferential tax treatment of housing assets.
  - Deepen regional cooperation and clarify common bank resolution procedures: introduce binding macroprudential minima and clear burden-sharing arrangements with safeguards against moral hazard.
  - Use development of a Banking Union as an opportunity for deeper regional coordination aligned with broader European schemes.
- Authorities’ statement:
  - Welcomed the regional surveillance exercise; acknowledged close linkages and shared policy preferences.
  - Emphasized country-specific differences justify tailored national macroeconomic and micro- and macroprudential regulation.
  - Noted reforms: phasing-in of higher minimum capital requirements with additional buffers for SIFIs; steps to establish legal and institutional macroprudential frameworks including a countercyclical capital buffer; measures to improve banks’ liquidity and reduce reliance on short-term market funding; increased capital adequacy ratios and more robust funding structures since the financial crisis.
  - Supported setting schedules for reaching the 100 percent LCR and the 100 percent NSFR, noting EU/EEA rules on these issues are yet to be finalized.
  - Highlighted difficulty in assessing housing valuation deviations from fundamentals and emphasized careful evaluation of mortgage interest deductibility changes within broader tax reform.

### Historical context and cooperation
- Nordic cooperation highlights:
  - Key milestones include formation of consultative structures and agreements from 1951 onward, Nordic Passport Union (1958), Nordic Convention on Social Security (1955), Helsinki Treaty in force Mar 24, 1962, Nordic Council of Ministers set up in 1971.
  - Sweden and Finland joined the European Union in 1995; Finland adopted the euro in 1999.
  - Post-1991 developments include closer cooperation with the Baltic States and institutional collaboration (e.g., Nordic Investment Bank, Nordic Industrial Fund).

*Italic: Source — Chapter III of Selected Issues and related excerpts from the Nordic Regional Report; Press Release No. 13/324 (September 5, 2013).*

### INTRODUCTION _________________________________________________________________________________ 4

### INTRODUCTION

### Overview and purpose
- This report examines the regional strengths and challenges of the four continental Nordic countries––Denmark, Finland, Norway and Sweden (henceforth the Nordic-4).
- Aim: identify common challenges and shared risk, and discuss implications for national policies and benefits from further regional cooperation.
- The Nordic-4 share the “Nordic model”: growth-enhancing trade and financial openness, stable public finances, cooperative labor markets, and equitable income distribution.

### Key observations on recent performance
- The Nordic-4 suffered severe downturns in 2009 as the global economy faltered, but outperformed other advanced economies in the recovery and emerged as safe havens during the euro area sovereign crisis.
- Despite strengths, the region faces: large cross-border banks, highly indebted households, and weak global growth which together raise vulnerability to cross-border shock transmission.

### Structural strengths supporting resilience
- Longstanding investments and policies: significant investment in R&D, education, infrastructure; active labor market policies; consistent macroeconomic policy frameworks.
- The Nordic model provides large—but fully-funded—public sector support mechanisms that enabled strong socioeconomic outcomes and high rankings in comparative studies (the Nordic-4 remained in the top 15 globally competitive economies).
- Prudent public finances and fiscal rules have contained gross public debt and built fiscal buffers, allowing automatic stabilizers to operate during the Great Recession.
- A strong “social contract” with robust social safety nets, universal healthcare and education, and tax policies geared toward employment has supported moderated wage pressures, high labor force participation, and low inequality.

### Openness: trade and financial integration
- Trade openness: total exports and imports of goods stood at over 60 percent of GDP, in 2012, of which 20 percent is intraregional.
- High specialization and export-led growth concentrated on raw-material based goods or highly specialized final goods sold into global markets.
- Financial openness:
  - The six largest banks in the Nordic-4 comprise roughly 90 percent of the total assets of all the region’s publicly-listed banks.
  - Roughly 85 percent of both the credit and deposits of these six banks come from the four Nordic countries.
  - Nordic banks are heavily reliant on wholesale funding, with covered bonds becoming an increasingly important source of financing.
  - On the asset side, the banking sector’s portfolio of private mortgages provides the counterpart to high levels of household debt.

### Transmission and spillovers
- Trade and financial openness make the Nordic-4 susceptible to both global and regional shocks; much cyclical variation is driven by external shocks.
- A structural macro-econometric model (covering 35 of the world’s largest economies) is used to estimate spillovers generated by trade channels, financial markets, and commodity prices, while accounting for regional comovement across the Nordic-4.
- Spillovers into the Nordic economies come predominantly from neighbors within the region and systemic advanced economies. Sweden-originated trade and financial shocks have the largest spillovers to the other Nordic countries.
- Outward spillovers from the Nordic-4 to the rest of the world are low, with the notable exception of potential outward spillovers to the closely-linked Baltic countries.

### Common vulnerabilities
- The combination of:
  - an outsized regional financial sector,
  - high household debt in each country,
  - reliance on domestic and foreign wholesale funding,
  - and constraints on the use of monetary policy for some Nordic-4,
  implies that shocks can be transmitted quickly across the region through banks to households and on to the broader economy.
- Household net asset positions often mask a mismatch between liquid assets (nonpension and nonhousing) and overall liabilities (debt).

### Policy implication (high level)
- Common vulnerabilities call for a combination of strong national policies and regional cooperation.
- Strong fiscal, financial, and macroprudential policies are essential at both the national and regional level to safeguard financial stability and better insulate the region from shocks.

*NORDIC REGIONAL REPORT — INTERNATIONAL MONETARY FUND*

### 14.       This background of robust

### _cr13274 - 14.       This background of robust

### Safe-haven flows, sovereign ratings, and funding implications
- Robust fundamentals made the Nordic-4 a destination for safe-haven flows as the euro area crisis peaked.
- The triple-A credit ratings of the Nordic sovereigns facilitated safe-haven flows into sovereign and private assets.
- For Nordic banks, this meant continued access to wholesale financing at relatively favorable rates, helped in part by legislative changes in the mid-2000s in Finland, Norway, and Sweden.
- Banks could turn to covered bonds at a time when unsecured debt came under the threat of “bail ins” globally.
- Finland and Denmark provide unique safe-haven opportunities: Finland within the euro area and Denmark as a hedge against convertibility risk.
- In Denmark, safe-haven flows loosened monetary and financial conditions and led the central bank to set one of its deposit rates at negative levels since July 2012.
- Norway and Sweden managed exchange rate appreciation through much of the later part of the crisis.
- The possible “tapering” of U.S. Federal Reserve bond purchases created some volatility in the relatively small Norwegian and Swedish currency markets.
- The absence of a significant weakening of the fundamentals in the Nordic-4 and little change in the level of global and European risk profiles suggest that a large-scale and excessive reversal of safe-haven capital flows remains a risk rather than a baseline scenario.

### Common domestic challenges and regional transmission
- Elevated house prices and high household debt levels leave households with modest liquid financial buffers, making it more likely that house price or interest rate shocks would be passed quickly into reduced consumption or defaults.
- Deeply integrated banking system and strong trade links could quickly transmit shocks across the region.
- Large regional banking sector reliant on wholesale financing implies high economic and fiscal costs from a tail event.
- In principle, costs would be borne entirely by the home country for branches and by the host country for subsidiaries; without regional agreements, uncertainties about burden-sharing could lead to elevated risk premia and prolonged uncertainties for the financial system and economy.

### A. Common challenges from household debt and house prices — empirical patterns
- House prices in the Nordic-4 rose in tandem from the mid-1990s until 2007 but diverged afterwards.
- House prices increased by more than 120 percent on average between 1995 and 2007.
- Since 2007:
  - Real house prices in Norway have continued to increase by more than 10 percent relative to 2007.
  - Prices fell by close to 30 percent in Denmark.
  - In Finland and Sweden, house prices have remained broadly constant.
- Housing market drivers:
  - Denmark experienced a construction boom and correction starting in 2006–07.
  - Finland, Norway, and Sweden characterized by supply shortages due to stringent zoning restrictions, construction requirements, and strict rent control legislation in some countries.

### Household balance sheets, liquidity, and vulnerability
- Household debt has reached levels well above the average of other advanced economies.
- With the exception of Finland, household debt has grown rapidly over the last decade, driven by rising house prices and easy and affordable access to credit, including mortgages with deferred amortization and high loan-to-value (LTV) ratios.
- Denmark’s household debt-to-disposable-income ratio is the highest in the OECD.
- While household assets are higher than gross liabilities in the Nordic-4, household assets as a share of disposable income are not as high in the Nordic-4 as in many other advanced economies.
- Large share of household assets is illiquid; housing wealth is subject to price risk; large share of financial assets are in pension accounts not readily available for other uses.
- If housing and pension/insurance assets are excluded, net liquid assets as a share of disposable income are negative in Denmark and Norway and low in Finland and Sweden.
- Macroeconomic sensitivity: Cross-country econometric work (see Chapter II of Selected Issues) suggests that a 10 percent decline in property prices will:
  - reduce aggregate GDP by as much as 2½ percent,
  - reduce private consumption by as much as 3½ percent,
  - reduce private residential investment by as much as 28½ percent.

### Policy responses and structural factors
- Authorities are starting to address policies that contributed to high prices and high debt:
  - Until recently, regulations on mortgage amortization and LTV ratios have been absent, and in the latter case are still not binding.
  - LTV ratios vary considerably across the region; Denmark has the most stringent LTV requirements.
  - Norway and Sweden have guidelines for LTV, which are generally adhered to by banks.
  - Recommendations on LTV limits exist in Finland but have yet to make an impact.
  - Norwegian and Swedish authorities are raising risk weights for mortgages.
  - All four countries provide generous tax preferences for housing, such as advantageous mortgage interest deductibility; together with deferred amortization and low rates this will continue to encourage excessive household indebtedness.
  - Structural rigidities: zoning regulations and rent controls; Finland and Sweden municipalities enjoy monopoly over planning and zoning; Norway land use regulations and minimum size and quality standards have restricted supply.
- Stress tests and buffers:
  - Stress tests suggest Nordic banks’ capital buffers would likely be sufficient to absorb the direct impact of lower house prices on credit portfolios, assuming historic parameters remain stable.
  - Mortgage lending historically exhibited low default rates and low loss-given-default rates due to full recourse and generous social safety nets.
  - Should bank funding costs increase in tandem, additional losses would be incurred if these costs cannot be passed through to borrowers.
  - A number of channels identified, including the need to increase overcollateralization in cover pools as LTV ratios rise with the decline in house prices.

### Authorities’ views
- Norwegian authorities agree high household debt and elevated house prices present risks; note divergent home country regulation may contribute to reinforced credit growth by some foreign banks operating in Norway.
- Swedish authorities recognize equilibrium of elevated prices and high household debt and have taken measures including capital and liquidity regulation, mortgage LTVs and risk weights.
- Finnish authorities do not detect a problem of valuation but are wary of risks from not having binding legislation on LTV ratios in very loose financial conditions.
- Danish authorities believe that after a large correction since late 2006, house prices are now broadly in line with fundamentals and that segregation of housing finance into covered-bond-financed mortgage banks should largely insulate commercial banks from defaults on home mortgages.

### B. Shared risks from a pan-Nordic financial sector
- Nordic banking sectors are well-capitalized with capital-to-asset ratios broadly in line with peers.
- Regulatory core Tier 1 capital ratios for deposit-taking banks:
  - Denmark: 16.7 percent (latest available data)
  - Finland: 15.5 percent (2013:Q1)
  - Norway: 13.2 percent (2012:Q4)
  - Sweden: 11.3 percent (2012:Q4)
  - All are above the 9 percent minimum set by the European Banking Authority.
- Pan-Nordic bank expansion increases spillover risks: cross-border operations mean shocks in one subsidiary or branch can spread across the region.
- Example: Nordea — subsidiaries in Finland and Denmark are larger than the Swedish parent.
- Size of the Nordic banking system increases crisis severity: publicly-listed assets equivalent of up to 400 percent of GDP changes the nature of a crisis relative to past episodes.

### Funding structure, covered bonds, and resolution concerns
- Loan-to-deposit (LTD) ratios are almost twice as high as the average of the largest banks elsewhere in the world.
- Households tend to save through pension and mutual funds rather than deposits or mortgage amortization, channeling savings back to banks via institutional investors mostly in the form of longer-term covered bonds.
- A self-reinforcing cycle has developed between credit growth and increasing wholesale funding needs.
- Reliance on wholesale funding makes banks vulnerable to excessive reversals in safe-haven flows beyond those associated with normalization of market conditions.
- Increasing use of covered bonds raises concerns over asset encumbrance and availability of capital for bailing in creditors during bank resolution:
  - Covered bonds provide low-cost and stable long-term funding, reducing probability of default and risk to taxpayers.
  - Asset encumbrance can raise loss-given-default as covered bonds reduce capital available to other creditors, leading them to demand higher returns.
  - Covered bonds reduce assets available to deposit insurance funds, potentially increasing costs to taxpayers in bank defaults.

### Fiscal cost uncertainty from a regionally-systemic bank failure
- Liquidity costs and eventual losses to the sovereign from failure of a regionally-systemic bank are difficult to predict but could be substantial.
- Staff estimates of direct fiscal costs of a potential systemic banking failure (i.e., all six banks) vary substantially by country and by assumptions on which creditors/governments are bailed out.
- Example for Sweden:
  - Fiscal costs range from 90 percent of GDP if all creditors were bailed out and costs were assigned to the home country,
  - to just over 15 percent of GDP if only insured depositors were bailed out and host governments bailed out local depositors.
- Costs for other countries are lower but still quite high and vary substantially depending on assumptions about which creditors get bailed out and which governments backstop insured deposits.

*International Monetary Fund — Nordic Regional Report (excerpts from provided content)*

### Chapter III of Selected Issues). These examples demonstrate the significance of the downside risk,

### _cr13274 - Chapter III of Selected Issues). These examples demonstrate the significance of the downside risk,

### Overview and key concerns
- Downside risk from bank distress is significant even with well-capitalized banks; potential fiscal costs vary widely without well defined rules.
- Feedback loops between sovereigns and banks complicate potential costs given some governments’ sizeable stakes in the region’s largest banks.
- The Nordic-Baltic Memorandum of Understanding (MoU) on financial stability, crisis management, and crisis resolution was signed in August 2010 and established a Nordic-Baltic cross-border cooperation structure, including the Nordic-Baltic Stability Group (NBSG).

### Potential fiscal costs and burden sharing
- Simulations of bailout costs cover insured and uninsured depositors and senior unsecured creditors; two different burden sharing rules (DB: By depositor base; LP: By location of parent) illustrate sensitivity for the Nordic-4.
- Clear, specific, and enforceable ex ante burden sharing agreements would:
  - Allow authorities to select the most effective crisis solution and avoid a scramble for ex post solutions.
  - Reduce incentives for fiscal over-insurance compared to when contingent liabilities are considered only from a national perspective.
- Views among authorities differ on bail-in versus bail-out and on usage of taxpayer funds; some emphasize flexibility of bail-outs while others emphasize moral hazard concerns from bail-outs.

### Policy agenda for the Nordic region — Strong national policies
- National reforms under way include:
  - Denmark: reducing banks’ dependency on state guarantees; implementing additional capital requirements for systemically important banks.
  - Finland: reducing incentives encouraging debt-financed house purchases by lowering the share of mortgage interest deductible from taxable income.
  - Norway: on track to implement a counter-cyclical capital buffer in mid-2014.
  - Sweden: increased capital and liquidity buffers and introduced a risk-weight floor for mortgages.
  - Denmark and Sweden: securing flexibility to impose higher capital requirements in the context of the Capital Requirements Directive (CRD IV).
- Recommended national measures (staff):
  - Mortgages: Phasing-in minimum amortization requirements (especially in Sweden) and binding LTV ratios (noticeably absent in Finland).
  - Taxes: Phasing out tax advantages for home ownership—including mortgage interest deductibility common in all of the Nordic-4.
  - Capital: Adjust mortgage risk weights to compensate for high household debt and elevated house prices; strengthen capital buffers beyond the EBA 9 percent and Basel III targets.
  - Funding / Liquidity:
    - Maintain adequate liquidity through steps toward the 100 percent liquidity coverage ratio (example: Sweden’s requirement comprises all currencies totaled and also separately for euros and U.S. dollars).
    - Establish a clear schedule for reaching the 100 percent Net Stable Funding Ratio (NSFR) target by 2018.
- Fiscal buffers:
  - Strong fiscal buffers are important to provide capacity to take on additional debt in the event of a large bank resolution and to allow automatic stabilizers to work during volatility transmitted through trade channels.
  - Coordinated fiscal reaction across the Nordic-4 to a large external growth shock could yield significant gains compared with independent reactions (chart period noted 2012–2017 in staff calculations).

### Regional cooperation on financial sector policies
- Priority areas for active regional cooperation (staff):
  - Information: Active and continuous information exchange among supervisors and other authorities on the regional dimension of work, building on NBMF and NBSG coordination.
  - Reciprocity: Ensure branches of foreign banks adhere to local regulations and operate under conditions tailored to that market.
  - Macroprudential minima: Jointly-agreed regional minima to prevent regulatory arbitrage and cross-border concentration of risk. Examples:
    - Gradual movement to regional risk weights on mortgage assets at the Basel III floor of 35 percent.
    - Capping and enforcing LTV ratios at 90 percent or less for all new mortgages over the medium term.
- Joint preemptive efforts for regionally-important banks:
  - Strengthening capital and liquidity requirements across the Nordic-4 reduces probability of a pan-Nordic banking crisis.
  - Agreement needed on allocation of capital and liquidity among national subsidiaries and branches (e.g., convertible capital bonds) and joint plans for regionally-systemic banks chosen on mutually-agreed characteristics.
- Progress at regional and European levels:
  - The pending cooperation agreement for the Nordea Crisis Management Group specifies principles for cross-border resolution, including a group resolution plan updated annually by Nordea’s home authorities with active participation of other jurisdictions.
  - Bank Recovery and Resolution Directive (RRD), once adopted, should confirm national options including government bail-outs or broad private sector bail-ins after a minimum level of losses have been imposed on shareholders and creditors.
- Authorities’ divergent views:
  - Difficulty in specifying legally-binding burden sharing rules ex ante (for example, securing ex ante parliamentary agreement on country contributions may be impossible).
  - Differences over applying macroprudential minima at parent company versus country level.

### The Nordics and the Banking Union
- The Banking Union (BU) components: Single Supervisory Mechanism (SSM), Single Resolution Mechanism (SRM), and Deposit Guarantee Scheme (DGS).
- Membership implications:
  - Finland: automatic membership of the BU.
  - Norway: precluded from joining by its constitution.
  - Denmark and Sweden: choice to stay outside or join could result in diverse supervisory regimes across the Nordic-4 while up to three countries might fall under the same EU-based resolution framework.
- Potential benefits of BU membership:
  - Could smooth regulatory coordination, financial supervision, and cross-border resolution.
  - With SSM, SRM, DGS and a common fiscal backstop, BU membership could help mitigate tail risks, limit contingent liabilities affecting stressed sovereigns, and restore bank balance sheet health in crises.
- Authorities’ concerns:
  - Adequate representation for non-euro area members and possible mutualization of risk (e.g., through the SRM).
  - Banking union membership not possible for non-EU member EFTA states.

### Staff appraisal — conclusions and priorities
- The Nordic-4 (Denmark, Finland, Norway, Sweden) are highly integrated, open economies with strong trade and financial links to global markets and sound public finances but a very large and highly-concentrated banking sector reliant on wholesale financing.
- Key risks identified:
  - Severe tightening of international wholesale financing conditions could hit large banks and translate into large fiscal costs that must be allocated across the four countries.
  - Mix of heavily-indebted households with limited liquid assets, wholesale-financed banks, and elevated asset prices raises probability of severe negative feedback loops from house price corrections domestically and regionally.
- Policy priorities:
  - Strengthen national housing and financial sector policies: consider phasing out preferential tax treatment of housing assets, restrict availability of interest-only mortgages, and adjust mortgage risk weights to ensure adequate capital buffers while encouraging sufficient liquidity.
  - Maintain strong fiscal buffers to guard against costly tail events in the banking sector.
  - Implement cooperative regional policies: introduce binding macroprudential minima and clear ex ante burden-sharing arrangements to create a level regulatory playing field and reduce uncertainty about costs from large bank failures.
  - Leverage recent progress (e.g., RRD) and consider the Banking Union as a potential opportunity to ease coordination, while ensuring a common regional approach irrespective of EU developments.

### Box: Nordic cooperation since the mid-20th century (highlights)
- Key milestones:
  - Proposal for a consultative body: Aug 13, 1951; Nordic Council first session: Feb 13, 1953; Finland joined two years later.
  - Nordic labor market: Jul 2, 1954; Nordic Passport Union: 1958; Nordic Convention on Social Security: 1955.
  - Helsinki Treaty came into force on Mar 24, 1962; Nordic Council of Ministers set up in 1971.
  - Sweden and Finland joined the European Union in 1995; Finland adopted the euro in 1999.
- Post-1991 developments included closer cooperation with the Baltic States and continued institutional collaboration (e.g., Nordic Investment Bank, Nordic Industrial Fund).

*Italic: Source — Chapter III of Selected Issues from the Nordic Regional Report (internal IMF staff materials provided in the supplied content).*

### Box 2. Recent Economic Developments

### Box 2. Recent Economic Developments

### Denmark
- From late 2006, Denmark was hit by dual shocks: a domestic housing correction and the global recession.
- The correction in house prices led to a period of weak demand and strains on banks starting in mid-2008, compounded by rising insolvencies and unemployment as the global recession took hold.
- Danish banks were highly dependent on interbank funding and faced additional pressures in the fall of 2008 as international wholesale markets froze.
- From peak to trough, real GDP contracted by close to 6.5 percent, and exports of goods and services by 9.5 percent.
- While the duration of Denmark’s output decline was around the OECD average, its size was significantly larger.
- Growth has remained muted since the recovery in 2010, with output falling once again in 2012.
- Denmark’s slow growth predates the recent economic crises, and the economy has underperformed its regional peers during the past two decades.

### Finland
- Despite stronger household balance sheets, Finland was the worst hit in the euro area by the global crisis due to the collapse in export demand.
- GDP fell almost 8 percent in 2009 reflecting adverse trade and financial international spillovers.
- Exports fell dramatically in 2009 owing to their concentration in telecommunications and capital goods, both heavily hurt by the worldwide slump, as well as sharper-than-average output declines in major trading partners.
- A rapid recovery followed in 2010, as domestic demand surged, propelled by rising consumer confidence and renewed wage growth.
- Exports, which had collapsed more than 20 percent in 2009, never regained their previous vigor.
- Growth deteriorated in 2012, spilling over into 2013, as both domestic and external demand have stalled.

### Norway
- Norway was less affected by the global financial crisis than its continental Nordic neighbors.
- After three quarters of declining output, mainland GDP returned to growth in the second quarter of 2009.
- Norway’s resilience was underpinned by substantial macroeconomic stimulus, buoyant activity in the hydrocarbon sector, high public sector employment, limited dependence on the hardest-hit segments of global manufacturing, and the relative stability of the domestic financial sector.
- The Norwegian economy continued to perform well with mainland GDP growing steadily at 2½–3 percent, unemployment remaining low and stable at 3–3½ percent and core inflation running well below the 2½ percent target.
- The continuing buildup of assets of the sovereign wealth fund and the increasing share of the mainland economy supplying goods and services to the oil sector are leading to competitiveness pressures in other industries exposed to international competition.

### Sweden
- Sweden, together with Denmark, was the first of the Nordic-4 to falter in the Great Recession.
- Output peaked at end-2007 before turning negative in 2008, falling by over 6 percent from peak to trough.
- Exports and gross fixed capital formation fell by 12 and 16 percent respectively in 2009.
- Permanent and temporary employment fell by 2 and 7 percent respectively in 2009 while unemployment rose from 6 to 9½ percent by Q1:2010.
- Sweden led much of the rest of Europe in the recovery, but the economy decelerated in 2012 together with its main trading partners.
- Uncertainty about euro area developments contributes to weak investment.
- Housing credit continues to expand faster than disposable income, but consumers remain cautious overall.
- Headline inflation has turned negative, reflecting the strengthening of the krona amidst safe-haven flows, as well as the opening of a small output gap.

*NORDIC REGIONAL REPORT — INTERNATIONAL MONETARY FUND.*

### Box 5. The Nordic Banking Crises in the Early 1990s (Concluded)

### Box 5. The Nordic Banking Crises in the Early 1990s (Concluded)

### Recovery: policy actions and timing
- The floating of the currencies in the fall of 1992, with the ensuing depreciation and receding domestic interest rates, arrested the downturn in the Finnish, Norwegian and Swedish economies.
- The recovery commenced in all three countries in the following year and lasted for more than a decade.
- The recovery after the boom-bust cycle turned out to be long-lasting—first until the downturn in worldwide economic activity around 2001. After a short break, rapid growth continued until 2008.

### Drivers of the recovery and macroeconomic outcomes
- The main engine behind the recovery was an impressive growth in exports.
  - Export shares rose significantly in all three countries, most markedly in Finland and Sweden.
  - This rise continued for more than a decade.
- Current accounts, previously in chronic deficit, turned to seemingly permanent large surpluses.
- Inflation in the Nordic region stayed at a low level, around two percent per annum, throughout the period 1995–2007.
- Wages and prices remained surprisingly stable despite large exchange rate depreciations; the large exchange rate depreciations did not have any apparent impact on domestic price and wage levels.
- The high rate of unemployment contributed to wage moderation; unemployment remained high until the mid-1990s after which it fell steadily.

### Fiscal policy and consolidation
- Post-crisis fiscal policies in Finland and Sweden were directed first towards reducing budget deficits and lowering national debt.
- The fiscal consolidation efforts were large and successful: within five years, Finland and Sweden were able to move from deep deficits to some of the biggest surpluses in Europe.
- Norway is a special case due to the returns from the oil and gas sector.

### Longer-term performance relative to peers
- The Finnish, Norwegian and Swedish growth rates have remained consistently above the EU average since the depression of the early 1990s.

*Italic: Drawn from Jonung, L. (2011), “Lessons from the Nordic Financial Crisis,” prepared for the AEA meeting in Denver.*

### 0.5 percent of GDP in 2015, and

### _cr13274 - 0.5 percent of GDP in 2015, and

### Publication and context
- Press Release No. 13/324
- FOR IMMEDIATE RELEASE
- September 5, 2013
- On August 29, 2013, the Executive Board of the International Monetary Fund (IMF) discussed the Nordic Regional Report on Denmark, Finland, Norway, and Sweden as part of a pilot to cluster Article IV consultations and assess spillovers across interconnected countries.

### Key fiscal and budgetary figures cited
- "0.5 percent of GDP in 2015, and 0 percent by 2020"
- "Central government deficit of no more than 1 percent of GDP (by 2015)"
- "Central government non-oil structural balance deficit of 4 percent of GPFG assets 1/"
- "General government 1 percent surplus over the cycle"
- "Excludes automatic stabilizers"
- "Covers about 80 percent of CG expenditure, excludes automatic stabilizers"
- "n.a."
- "Determined for the next three years by Riksdag, includes automatic stabilitzers"
- Footnote: "1/ GPFG denotes the Government Pension Fund Global (the sovereign wealth fund)."

### Executive Board assessment — salient findings
- The Nordic-4 (Denmark, Finland, Norway, Sweden) share:
  - strong economic and social institutions;
  - a track record of fiscal prudence;
  - high degree of regional and global openness.
- Important variations across countries noted, including:
  - monetary and exchange rate regimes;
  - degrees of political and economic integration with the European Union.
- Shared vulnerabilities identified:
  - large, integrated, concentrated banking sectors;
  - high household debt;
  - elevated property prices;
  - close regional trade and financial linkages that can transmit shocks rapidly across countries and to the Baltic economies.
- National financial reforms and strong fiscal frameworks have created fiscal buffers.
- Nordic cooperation on financial sector issues exists, but burden-sharing arrangements for systemic bank failures are at an early stage.

### Financial sector structure and risks
- Nordic banking system characteristics:
  - well-capitalized by international standards;
  - highly integrated and large relative to the region;
  - concentrated;
  - heavily reliant on wholesale funding.
- Specific concerns and dynamics:
  - mix of large integrated banks, high household debt, and elevated property prices creates shared regional risks;
  - banks have supported large household borrowing to finance house purchases at high price levels;
  - household debt in parts of the region is among the highest within the OECD;
  - household net asset positions may mask mismatches between liquid assets and outstanding liabilities;
  - shocks can diffuse rapidly across the region, feeding back between banks and households and to the broader economy.

### Policy recommendations and measures endorsed by Directors
- Reinforce national policies on housing and banking to preempt systemic risks from house price corrections and banks’ wholesale funding dependence.
- Raise risk weights for mortgages to ensure adequate capital buffers while maintaining sufficient liquidity.
- Maintain strong fiscal buffers to guard against costly tail events in the banking sector.
- Restrict availability of interest-only mortgages.
- Gradually phase out preferential tax treatment of housing assets while considering alternatives within broader tax reforms.
- Deepen regional cooperation and clarify common bank resolution procedures:
  - introduce binding macroprudential minima to create a level regulatory playing field;
  - establish clear burden-sharing arrangements with safeguards against moral hazard;
  - continue progress on mechanisms to deal with distressed banks at Nordic and European levels.
- Use the development of a Banking Union as an opportunity for deeper regional coordination aligned with broader European schemes.

### Authorities’ (Denmark, Finland, Norway, Sweden) statement — main points
- Welcome the regional surveillance exercise; acknowledge close real and financial linkages and shared preferences for economic and social policies.
- Affirm that country-specific differences justify tailored national macroeconomic and micro- and macroprudential regulation.
- Agree with staff on:
  - the description of social and economic policy frameworks and the Nordic banking sector’s large size, concentration, intra-Nordic linkages, and reliance on wholesale funding (with covered bonds as a specific funding source in some countries);
  - the importance of strong fiscal, financial and macroprudential policies to safeguard financial stability.
- Noted reforms and ongoing measures:
  - phasing-in of higher minimum capital requirements with additional buffers for systemically important financial institutions (SIFIs);
  - steps to establish legal and institutional frameworks for macroprudential policy, including implementation of a countercyclical capital buffer, cf. Basel III and CRR/CRD IV;
  - measures to improve banks’ liquidity positions and reduce reliance on short-term market funding;
  - banks have increased capital adequacy ratios and funding structures have become more robust since the financial crisis.
- Support for further strengthening financial sector policies and need for thorough analysis of interactions between macroprudential measures.
- Recommendation that all countries establish clear schedules for reaching the 100 percent Liquidity Coverage Ratio (LCR) and the 100 percent Net Stable Funding Ratio (NSFR), noting EU/EEA rules on these issues are yet to be finalized.

### Housing, household debt, and related policy views from authorities
- Acknowledge elevated house prices and high household debt as main regional challenges; note difficulty in assessing deviation from fundamentals.
- Highlight concern about high household debt levels and low household net liquid assets as a share of disposable incomes.
- Note that historical losses to the financial sector from households have been very low across Nordic countries, but spillovers to other sectors are possible.
- Point out mixed housing market developments:
  - substantial drop in house prices in Denmark until recently;
  - continued house price increases in Norway;
  - more stable prices in Sweden and Finland.
- Existing and recommended measures:
  - various forms of Loan-to-Value (LTV) limits are imposed in all four countries; effectiveness depends on coverage of all credit institutions and supervisory monitoring;
  - residential mortgage loan risk weights are comparatively low in some large Nordic banks — authorities see this as an argument for higher risk weights and higher capital requirements;
  - Nordic FSAs are investigating differences in parameter estimates and resulting risk weights between Nordic banks;
  - awareness of potential risks from preferential tax treatment of housing; limiting mortgage interest deductibility could dampen borrowing, but changes should be evaluated within the overall tax system and housing market stability.

### Regional coordination, resolution, and supervisory cooperation
- Scope for coordination is strengthened by all four countries being part of the European financial market and subject to the same financial regulatory framework, though differences in EU relations and future Banking Union membership may challenge coordination.
- Risks from differences in home and host authority requirements may create competitive distortions.
- Nordic countries have established forums for information sharing and coordination at ministerial, central bank and supervisory levels; authorities agree on the need to strengthen cooperation on banking regulation.
- Views on ex-ante burden-sharing agreements for pan-Nordic banks are diverse:
  - ex-ante agreements could improve resolution efficiency but may induce moral hazard.
- Authorities emphasize each country’s ultimate responsibility for its macroeconomic and financial stability and the importance of national tools for effective policy implementation.
- No scope for fiscal coordination within the Nordic region; fiscal coordination for three of four countries is done within the framework of the European Union.
- Staff advocacy for host country regulation to ensure all banks operating in national markets are subject to rules tailored to market conditions.

*Source: Press Release No. 13/324, September 5, 2013 — IMF Executive Board discussion and Statement by Audun Groenn (August 29, 2013).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13274.pdf_