The Nordic Banking Crises: Pitfalls in Financial Liberalization?

IMF Working Papers, June 1, 1995

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The paper examines the recent banking crises in Finland, Norway and Sweden to draw policy conclusions from their experiences.
In all three countries, the timing of deregulation coincided with a strongly expansionary macroeconomic momentum.
Delayed policy responses were important determinants of the crises' consequences.
Structural characteristics of the financial systems and banks’ inadequate internal risk management controls contributed significantly to outcomes.
In the absence of strengthened prudential banking supervision, incentives coupled with expectations of government intervention prompted many Nordic banks to increase their lending excessively.

Timing of deregulation coinciding with strongly expansionary macroeconomic momentum.
Delayed policy responses to emerging vulnerabilities.
Structural characteristics of the financial systems (noted as important determinants).
Banks’ inadequate internal risk management controls.
Expectations of government intervention in the event of a crisis that altered banks’ risk-taking incentives.

Strengthen prudential banking supervision before or alongside financial liberalization to mitigate excessive risk-taking incentives.
Align the timing of deregulation with macroeconomic conditions to avoid releasing credit into an already expansionary environment.
Improve banks’ internal risk management controls to limit excessive lending during transitions to more competitive financial systems.
Address structural features of financial systems that can amplify vulnerabilities during liberalization.
Reduce moral hazard by clarifying limits or conditions on government intervention to avoid encouraging excessive lending.