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International Monetary Fund
Finland has a very sound financial system. Finland is at the forefront of electronic banking and financial sector consolidation. Arrangements for crisis prevention and management need to balance the conflicting goals of minimizing moral hazard and providing adequate safety nets in the financial system. There are some deficiencies as regards compliance with certain of the banking supervision and securities standards. In view of the advanced stage of development of Finland's financial system, supervisory arrangements will need to meet and even exceed international standards.
Ms. G. G. Garcia

Abstract

This paper demonstrates a well-designed deposit guarantee system can strengthen incentives for owners, managers, depositors and other creditors, borrowers, regulators and supervisors, and politicians. Borrowers should be aware that they will have to repay their loans if their bank fails and will be encouraged to keep their loans current where offsetting is limited to past-due loans. The performance of insurers, regulators, and supervisors as agents will improve where they know that they can take justifiable actions without political interference and will be held accountable for their actions to their principals. Despite the improvements, and possibly partly because there are issues in deposit insurance design that remain to be resolved, financial crises have been prevalent during the 1990s. This situation has forced a number of countries to offer a blanket guarantee to restore confidence and to allow the continued functioning of the financial system while the authorities take time to design a plan for the resolution of the crisis.

Mr. Burkhard Drees and Ceyla Pazarbasioglu

Abstract

This study examines the banking crises in Finland, Norway and Sweden, which took place in the early 1990s, and draws some policy conclusions from their experiences. One key conclusion is that factors in addition to business cycle effects explain the Nordic countries financial problems. Although the timing of the deregulation in all three countries coincided with a strongly expansionary macroeconomic momentum, the main reasons for the banking crises were the delayed policy responses, the structural characteristics of the financial systems, and the banks inadequate internal risk-management controls.

Mr. Burkhard Drees and Ceyla Pazarbasioglu

Abstract

The banking industries in several industrial countries, including the Nordic countries, underwent considerable change in the 1980s.1 It was a period marked by economic deregulation, the removal of cross-border restrictions on capital flows, financial innovation, and increased competition in financial services. At the same time, distinctions between types of financial intermediaries became increasingly blurred. These changes were accompanied in most countries by a sharp credit boom followed by a period of financial fragility, as lower asset quality and interest margins weakened banks’ balance sheets. In a number of industrial countries, banks’ financial performance deteriorated to the point where governments had to support some of the largest banks to preserve financial stability.

Mr. G. G. Johnson

Abstract

In most countries, banks are the most important financial institutions for intermediating between savers and borrowers, assessing risks, executing monetary policy, and providing payment services. At the same time, the configuration of their portfolios makes them especially vulnerable to illiquidity and insolvency. In particular, by law, bank deposits have to be repaid at par: in addition, banks are highly leveraged and often maintain liquid assets to meet withdrawals only in normal times. In light of this vulnerability, government officials realize that the demise of one bank, if handled poorly, can spill over to others, creating negative externalities and causing a more general problem for other banks in the system. For these reasons, many governments provide a safety net for banks that generally includes deposit protection and lender-of-last-resort facilities, in addition to a system of bank regulation and supervision. Recognizing that financial stability is a public-good with regional, and even global, implications (see Wyplosz, 1999), the international community is showing an interest in deposit protection.

Mr. Burkhard Drees and Ceyla Pazarbasioglu

Abstract

In the early 1980s, the banking systems in Finland, Norway, and Sweden were heavily regulated. The regulations, which shaped the structure of their financial systems, were motivated largely by the same principles and objectives in the three countries. Besides securing the stability of the banking system, they were designed to maintain low and stable interest rates and—particularly in Norway and Sweden—to channel subsidized credit to specific priority sectors, such as housing and government. As a result, the Nordic countries in the late 1970s and early 1980s were characterized by widespread credit rationing. The chronic excess demand for credit fostered close and long-term relationships between borrowers and their banks and allowed banks to be highly selective in choosing relatively safer credit risks. At the same time, bank profitability was largely ensured by restrictions on competition from other domestic and foreign financial institutions.

Mr. G. G. Johnson

Abstract

The proliferation of banking and financial crises during the 1980s and 1990s has led a large number of countries to institute, or consider instituting, an explicit system of deposit insurance (see, for example, Lindgren, Garcia, and Saal, 1996).2 In fact, 30 of the 72 countries now known to have an explicit deposit insurance system established it during the past decade; 49 set up their systems in the past 20 years. During the 1990s, 33 countries reformed their deposit insurance systems, often to improve its incentive structure in light of experience.3

Mr. G. G. Johnson

Abstract

A recent survey of 85 different systems of deposit protection found that of the 85, 67 countries offered an explicit, limited deposit insurance system in normal times (see Table A1 of the Statistical Appendix).46 They are the focus of the survey that follows.47 As Table 2 shows, four of the surveyed countries are in Africa, 10 are in Asia, 32 are in Europe, four are in the Middle East, and 17 are in the Americas.

Mr. Burkhard Drees and Ceyla Pazarbasioglu

Abstract

The regulation of the financial markets in the Nordic countries led to significant distortions in the allocation and pricing of credit. However, regulatory protection was not sufficient to isolate segments of the financial system from market forces completely. As one would have expected, market participants in the Nordic countries found ways to circumvent interest rate restrictions as the tensions in the financial systems increased markedly in the early 1980s.

Mr. G. G. Johnson

Abstract

While a well-designed, limited system of deposit insurance can protect small depositors’ funds in normal times, help to avoid unjustified runs, and provide a framework for the efficient resolution of individual failed banks—thus enhancing systemic stability—a limited system cannot be expected to maintain systemic stability in the face of an unforeseen shock of massive proportions or where weaknesses have been allowed to become so widespread that the system shudders even in response to smaller shocks. Faced with such a scenario and recognizing that financial stability is a public good, the government may decide to take emergency action to preserve the stability of the financial sector. It may also choose to bear the costs of the economic emergency and override the system of limited deposit protection and offer a full, temporary guarantee of depositors and creditors to ensure the continued functioning of the financial system. That guarantee should, however, be removed as soon as possible and replaced by a formal, limited, compulsory system of deposit protection that is funded by the banking system and supported by a good incentive structure, including effective regulation and supervision.