Governor Svein Gjedrem
Norges Bank Conference on Banking Crisis Resolution - Theory and Policy, Oslo, June 16, 2005
I am pleased to see so many of you here at this conference on Banking Crisis resolution - Theory and Policy. Altogether 80 participants from more than 30 countries in Europe, Asia and North America are present here today. I wish you all a warm welcome to Oslo.
Banking crises used to be something of the past. Then came the 1990s and it was suddenly something we all had to deal with. Of course, had we looked back in history, we should have known better.
Even in fiction, banking crises feature quite prominently. Charles Dickens was inspired by the large banking scandals of his time when he wrote Little Dorrit and The Way We Live Now. In Ireland, the sensational failure in 1856 of the Tipperary Joint-Stock Bank had far-reaching ramifications. When the bank collapsed, its liabilities were ten times its assets. At the same time in England, the collapse of the Royal British Bank received wide publicity. The bank had put most of its capital into Welsh gold mines in the vain hope that Wales would prove to be the next California. However, when the bank collapsed, it was discovered that the directors had made secret loans to themselves and their friends.
So perhaps, had we spent more time reading novels, we might have learnt from history and avoided some of the banking crises of the 1990s.
Our former Governor Hermod Skånland noted that banking crises are often related to bad policy, bad banking, and bad luck. All these elements were present in the Norwegian banking crisis. Let me comment briefly on each:
Bad policy certainly played its part in the crisis. The sequencing of liberalisation measures could have been different, tax policies could have been timed better, supervision could have been better, fiscal polices more flexible, etc. etc. However, I find much of this critique misplaced, because it has largely been given with the benefit of hindsight. At the time, policy makers did not see things as we see them today, the credit boom was not as visible, the sharp private sector adjustment was not anticipated, and the exchange rate regime could not have been altered so easily. We should learn from our policy mistakes, but an equally important lesson is the ignorance of the moment and how to deal with crisis resolution in the midst of poor real-time data. That was, and will continue to be, a challenge.
Bad banking also played a large part in the build-up to the crisis. There are many examples from the Norwegian crisis that illustrate how similar banks fared differently due to different business models. Those that failed were typically dazzled by the prospect of easy profit, leading them on to reckless expansion. Unfortunately, the fight for market shares took precedence over prudent banking policy. But many other banks prevailed through the crisis, notably in the saving banks sector. They can teach us a lesson about how to withstand "popular delusions and the madness of crowds" 1, which is certainly not easy in the midst of a boom.
Bad luck also played its part in the Norwegian crisis. The sharp decline in oil prices in 1986 reduced national income and led to a sharp fiscal correction that preceded the banking crisis. Later, German unification led to a new era for Europe, but its timing and impact on our stabilization policies was "bad luck".
Charles Kindleberger has - in his famous book Manias, Panics and Crisis - described how bubbles can turn into crashes by some sort of exogenous shock. The trick, obviously, is to get out of the market before the shock pricks the bubble.
One of our great Norwegian novelists, the Nobel prize winner Bjørnstjerne Bjørnson, in a novel called The Failure, describes how a local capitalist (Tjælde) explains his investment philosophy to his daughter:
You have to understand that a businessman
must have confidence in the
market, always hope for the better. He is
therefore not a swindler, but an optimist, a
poet if you wish, living in an imaginary
world. Or perhaps he is a genius that sees
what no-one else has yet seen?
His daughter (Valborg) is not quite convinced and argues that:
what you call hope, poetry or genius,
isn't that just speculation with others'
property, especially when you already owe
more than you own?
Upon which her father remarks, that:
Just to determine when (that balance is
passed) can be very difficult.
Tjælde was hit hard by adverse external events. At the time, though, he sees only opportunities. And, if the negative shock (bad luck) hadn't occurred - he might indeed have ended up as a genius.
What actually determines the boom and the bust has indeed engaged many famous economists. Knut Wicksell in an article (in Statsökonomisk Tidskrift, 1917) - The Riddle of the Crisis - pointed out two very different explanations for the cycle: One, relying on an external shock, or the other, which claims that there are inherent instabilities in the economy that tend to result in repeated oscillations. Wicksell inclined to the latter view, but also believed that an intelligent credit policy could prevent the rocking tendency from growing violent.
Today, we base our flexible inflation target regime on many of his ideas. Indeed, I believe we have found a fairly good balance between a stable policy environment and flexibility to handle unforeseen external shocks. However, we need to be vigilant in our pursuit of price and financial stability.
With hindsight, I believe our banking crisis was handled reasonably well. It was not, however, without cost. You can read more about the crisis in our Occasional paper called The Norwegian Banking Crisis that was issued last year. This conference picks up on several of the issues that were raised during our work on that paper, such as
- the role of the central bank in banking crisis resolution
- the role of blanket guarantees
- the role of government in banking crisis resolution, and
- the challenges posed by increasing cross-border banking, especially for smaller countries.
I look forward to the presentations at this conference and hope you will all participate in the discussions.
1"Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay, 1841.