Changes in Financial Market Regulation from Pre-Crisis to Post-Crisis Period in Finland

Abstract

Since 2008, Finland has experienced a severe financial crisis characterised by a systemic banking crisis and a significant economic adjustment. As has been well documented, Finland had a protracted property and credit boom which contributed to unsustainable domestic imbalances prior to the crisis. Furthermore, the economic adjustment coincided with, and was exacerbated by, the global financial crisis, which began in 2007. The scale of the Finnish State’s outlay, in terms of recapitalisation and other policy measures (e.g., National Asset Management Agency, Government guarantee on liabilities) to deal with the severe problems faced by the banking sector, created significant actual and contingent fiscal liabilities and transformed banking sector risk into sovereign risk. Against the background of heightening tensions in European sovereign debt markets, these risks intensified from late-summer 2010, resulting in Finland applying for external assistance in November 2010. Under the EU/IMF Programme, Finland is adhering to a timeline of targeted measures promoting banking stabilisation, fiscal consolidation and structural reform.The impact of crisis-related measures and implications of exit for bond markets Some participants felt that there had been a meaningful improvement in market conditions. A number of market indicators such as Libor-OIS spreads, credit spreads and credit default swaps had normalised, and some central banks – for example, the Federal Reserve Bank of New York – were beginning to unwind some of the liquidity measures and asset purchase programs introduced at the height of the financial crisis. While some participants noted that there was now some upward pressure on interest rates, overall this pressure was range-bound. However, some words of caution were also noted. In particular, 2010 would be a period of transition to higher yields, which could be tricky to navigate. While long-term expectations are relatively well anchored, some volatility might be expected in the front end of the yield curve until the economic recovery becomes fully embedded. Nevertheless, there was a clear sense that the economic recovery is moving from fragile to sustainable. Interestingly, it was reported that CEOs and company managers appear to be more optimistic than analysts at this particular juncture. There has been an enormous amount of restructuring in the corporate sector and productivity gains are beginning to emerge. Fixed costs have been shed and labour costs have been more flexible; consequently, profits are improving, despite little change in the top line revenues.Other participants were less sanguine and cautioned that conditions might actually become more challenging in two to three years – at which point the corporate sector will likely need to return to capital markets and most of the government guaranteed debt will mature. It was also pointed out that, while access to credit had generally improved, there were clear difficulties for small and medium enterprises (SMEs) and smaller financial institutions. Another particular area of concern was the asset-backed securities (ABS) market, where the recovery is still fragile and might stall once specific support measures are withdrawn. The withdrawal of the policy stimulus and sovereign risk were singled out as the two biggest concerns for investors over the next six months, whereas inflation was thought to be the least relevant. A number of participants focused on sovereign risk and the possibility that the financial crisis might evolve into a sovereign debt crisis. The public sector overreliance on short-term debt was highlighted with nearly a third of the US government debt falling due in 2010 and government guaranteed debt also weighing adversely on redemptions over the next two years. In contrast, despite the significant pick-up in net issuance, the position of the UK was deemed more favourable owing to the very long average maturity of its debt and the role of its domestic pension fund base. Participants expressed concern on the outlook for Greece and the risk of contagion to other sovereigns in the euro area and stressed the need of a prompt policy response. The debate also addressed the issue of the timing and speed of exit. There was clear recognition of the need for fiscal consolidation and a reversal of monetary accommodation in the medium term, but participants cautioned against removing the economic stimulus too rapidly. In particular, it was highlighted that the lack of credibility in fiscal consolidation plans and in the course of monetary policy may have to bear an undesirably heavier adjustment burden.