Ireland moves towards adoption of Swedish model to deal with its financial crisis

In his column in the Irish Times, Simon Carswell reports on how the Irish central bank will draw on the Swedish central bank's institutional memory of the Swedish model for handling a bank solvency led financial crisis.

Regular readers know that under the Swedish model banks are required to absorb the losses on the excess debt in the financial system today.  They subsequently recapitalize themselves by retaining 100% of pre-banker bonus earnings.

Having the banks absorb the losses on the excess debt protects the real economy as it removes the burden on the real economy to repay this excess debt.  Instead of going to debt repayment, capital in the real economy can go to reinvestment and investment in growth in the real economy.

Lars Frisell, the Swedish economist who took over as director of economics and chief economist at the Central Bank in June .... has all the credentials to give the Central Bank the “institutional memory” he spoke of last week in his first public speech in Ireland, when he referred to the effect of Sweden’s financial crisis in the early 1990s on the country’s bankers. 

In his speech, Frisell gave his perspective on the “causes, culprits and cures” of the financial crisis in Ireland and drew interesting comparisons between Ireland’s current situation and how Sweden got into – and out of – its crisis. 

He told the Institute of Certified Public Accountants that the “institutional memory” of the Swedish crisis 20 years ago tempered the boom in lending by Sweden’s banks into the Baltic countries in the decade before the most recent crisis. While bankers did almost the same thing as in Sweden in the 1990s, it was on a smaller scale in the Baltics, he said. 

Frisell said that when the Burlington Hotel sold for €288 million in 2007, or €600,000 per hotel bedroom, someone should have said stop, but that even a small group of naysayers was not enough. 

“Even if there are a few people – maybe a few academics, a few journalists who would be the beacons of sanity – they are usually not enough to stop it,” he said. 

Frisell was also startled that nobody saw “something seriously wrong” in a country that was building almost 100,000 new homes at the peak of the boom when Sweden, which is twice the size of Ireland, was building 30,000 new homes a year. 

He blamed the Irish crisis on four areas – the corporate culture at the banks, the corporate governance at the banks, the role of “trusted third parties” and the failure of the authorities and politicians. 

The culture of the banks was affected by incentives such as bonuses based on loan volumes while the bank boards, who represented big shareholders, should have been aware of the risks being taken. 

Catering to his audience last week, Frisell said that accountants were among the trusted third parties who should have been protecting the interests of small shareholders and the banks’ creditors. 

Accountants play an important external role to protect outsiders, he said.... 

Frisell argued that the incentives for accountants – the payment of hundreds of thousands of euro in audit fees every year – was “clearly stacked in the wrong way”. 

Auditors will undoubtedly be wary of criticising the business models of a bank if there was a risk of losing the audit job. 

Frisell said that the Swedish regulator previously had financial accountants within the banks reporting back to them but they were later withdrawn in favour of a more hands-off model because they could be blamed if something went wrong. 

The regulator’s role was not to follow a bank’s business day-to-day but to ensure the rules of the game were being followed. 

This raises interesting questions for the more hands-on role that the Central Bank has adopted at the Irish banks since the crisis, with supervisors from the regulator sitting in on meetings of bank boards.... 

The banks won’t have liked it but Frisell did say that debt forgiveness had a role to play in the new personal insolvency law to alleviate the heavy burden of household debt but it involved a “tricky balance”. 

Sweden’s experience of debt forgiveness is different, however, given that the country’s over-indebtedness related mostly to commercial property, not residential or buy-to-let properties. 

Frisell told me later that the conditions for debt forgiveness were “pretty tough” – you had to live on a minimum salary for five years before debts were cleared.