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Many factors precipitated the banking crisis in Finland--just as they did in other countries. Particularly important, however, were the economy's plunge into a deep recession and the resultant inability of customers to meet their commitments. The crisis will probably be surmounted only after the economy is on the road to recovery again. Before that, the structures of the banking sector will change fundamentally--or at least they should change.
A far-sighted person could have anticipated the coming banking crisis as early as 1984-85, when it became necessary to take a temporary step backwards in the deregulation of capital movements. At that time foreign investors began to show a very keen interest in markka bonds issued in Finland because of the high interest rates they carried and the expectation that the markka could only strengthen.
Because of a continuing heavy currency inflow, the Bank of Finland decided in mid-1985 to ban the sale of new issues of markka bonds to foreigners. Apparently this decision was motivated by the view Finns were running up debt on bad--too expensive--terms and that liquidity was improving at too rapid a rate. While it lasted, the boom in sales of markka bonds nevertheless showed that the "hunger for money" was really great in Finland's regulated markets.
TIMING FAILED
The dismantling of credit rationing and liberalisation of capital imports in 1986 seemed to take place at a relatively good point of time. Economic growth was, according to forecasts, clearly slowing, other countries had proceeded further in market liberalisation--and no major problems had so far appeared.
But the forecasts of developments in output proved to be badly mistaken. In fact, a long vigorous upswing started, which lasted until the early months of the 1990.
Secondly, the financial markets were liberalised in a highly "asymmetric" fashion. In the background one can discern mainly political reasons. The Bank of Finland's base rate remained a pawn of politicians, making any rise in the rate of interest on outstanding loans virtually impossible. The only way in which credit expansion could be restrained was in the narrow area of market rate lending while the base rate lived a life of its own.
Decision-makers also failed to see what was happening in the terms of trade. Import prices fell...