 So good morning, everybody, also from my – and first let me thank the organizers for the invitation to deliver this talk. It's a great pleasure to be here, and it's my first visit to Vietnam also. Unfortunately, it's a brief one I should stay longer, but it's not possible. I should also say that the – by the way, that the – apart from the YouTube and so forth, the slides will be available on the Bank of Finland website after this presentation. So let me – here's the outline of my talk. I will just very briefly talk about the background, the historical background to the developments, then more in Europe and a little bit internationally. Then let's just brief summary. Then we look at the Nordic countries. I will tell a little bit about the Nordic countries in general and then about the financial systems during the regulation time. And then we'll look at what the main steps of regulation were and get to the main issues and difficulties there in the Nordic deregulations and the lessons. And then also, if we have time, a little bit about the crisis management. So there's a lot of material, especially in the first part on the slides, and I'll just go quickly over it. So the useful starting point really for this financial deregulation period is really World War II. There was great – in Europe in particular, there was great destruction on the war in most countries, many countries, and the economies obviously had to go back to basics in some ways, ask how to fund the reconstruction and industrial development. That was the main goal of the financial system. And the regulatory frameworks were tight controls, rationing credit controls on interest rates and so forth. And obviously also, after World War II, the public debt levels were very high in most countries. Then the process went on. There was a gradual lifting of financial controls that started already in the 1950s and continued until the 1970s in most European controls. And interest rate controls were part of this. They were lifted in – depending on – some timing was different in various countries somewhat. There were other deregulations also on the financial services and et cetera. I will not go into the details of these too much. The other front is the external dimension, of course. And so after World War II, basically there were fixed exchange rate dreams, tight capital controls as well. Then came the Bretton Woods developments, the institutions IMF, OECD. European Payments Union came already at the end of the 40s to handle killing of trade balances and some trade credit, obviously European Economic Community, OECD. And this quest for also which is important is the liberalization of capital movements. That was initiated already these ideas in the early 1960s. Some countries had, in fact, already – were already without capital controls and I'm listing some countries there. Of course then came the Bretton Woods system broke down in the early 70s and that created a turbulent period in Europe. Something called the European Monetary System was created in the late 70s. That was basically a fixed exchange rates but adjustable ones and some mutual support there. And then in the 1980s this trend towards capital account liberalizations was renewed in Europe in the European Union. And then the Maastricht Treaty in the beginning of the 90s made it really one of the corner stones of European Union to have free movement of capital. The banking systems and financial systems I already mentioned, that was a gradual process and let me not get into details, it also became important in the EU level earlier and in particular right at the end of 1980s there was EU legislation on single banking license and single permit or passport for investment services, single market for financial services, etc. So there was a big push for unified financial markets and financial systems in European Union. There was one exception though which was that the banking supervision was left at the national level. There were discussions about that in the 90s about that as well. If we look at this whole process in terms of the banking side in Europe, what is remarkable is that there were very few financial crises, very few banking crises. There were problems with individual banks so there's a list there on the slides, but there were four major systemic banking crises as part of this process. Three Nordic countries in the early 90s and I'll obviously get to the details as I promised and then the other fourth case is Spain at the end of the 70s or early 1980s and these crises are big. I mean there's this well-known book and work by Climb and Reinhardt and Ken Rogoff and that lists the big five crises in advanced market economies before the current one and the three Nordic countries are there, Spain is there and then the fifth one is Japan in the early 90s. So relative to GDP the Nordic crises are big and they hopefully provide some useful lessons. So let me then move on to the Nordic countries and the first question is obviously why are they important? These are small countries but I guess they are generally important for considered to be advanced economies with high welfare states but nevertheless strong market economies. In terms of the finance deregulation story of course it's the three crises that are important, make them important. So that's not entirely a success story but there are some success parts to it as well especially in crisis management. So anyway here's the brief background on Nordics. I'm excluding Iceland, I should say I'm excluding Iceland, that is a fifth Nordic country but this is Denmark, Finland, Norway and Sweden. So altogether quite small population about 22 million and they've had widespread ties between themselves. For example a common labor market was established already in the early 50s. Sweden actually stayed out of World War II so they had strong, they were the wealthiest in the 1970s and Finland had the biggest problems with wartime. We were heavily involved, had to defend the country against Soviet Union and we suffered a lot but managed to keep the Soviets out of the country. And then, and so that's the setting there, as I said the tight capital controls on finance and also foreign payments and so forth were in place in all of these countries right after World War II. Gradually already at the end of 1950s the foreign trade and associated payments schemes were liberalized. So that was an early part of the liberalization but so that is worth noting there. More generally these countries of course are known about the welfare state being egalitarian, socially cohesive with a strong democratic tradition, a relatively big public sector and it has still a strong influence on the economy, it had much bigger influence at that time in the 50s and 60s and 70s. As I said they were tight controls so this financial repression was prevalent very much so and it was used as an instrument for growth and industrialization policies. You have to have obviously the reconstruction after the war, especially in Finland but also in other countries and this quest for faster growth. And that meant that there were these, here's some data on it. So the comparison is this backward constructed data that red line on Euro area which you can view as sort of a Western European average and here are the four countries. So you can see, this is an index number, zero is at 1,100% is at 1985 and you can see that on the whole these countries have been growing rather fast. You can also see in the early 90s the big financial crisis there, especially big in Finland and I'll come back to the reason, but also Sweden and less so in Norway but there were also aspects of the crisis in Norway there. It started already in fact in the 80s there. So that's the growth performance. These countries also had high inflation, faster inflation than in several other Western European countries. So here's the reference countries are Germany in light blue and United States in red and you can see in this long series of consumer prices that the inflation was notably faster in the three, four Nordic countries. Here is the currencies, how the exchange rate behaved against the German mark in this period from 1960 onwards and you can see there little clips there, upward clips there and those are the devaluations and you can see there was a trend that the country, these Nordic currencies weakened against the German mark and that continued until the 90s, mid-90s roughly speaking. And there were big current account deficits. So this is somewhat shorter series from 1980 onwards and you can see that especially if you look at the countries you can see Finland almost always with deficits until mid-90s, Sweden also not so systematically but tended to have deficits. Norway is a different story because Norway of course became an oil producing country when the oil in the North Sea and on the coasts of Norway was discovered and made use of during the 1970s and they tended to have current account surpluses already in the early 80s and then there was a breakdown of the OPEC cartel in 1986 which you see very clearly in the green line for Norway and they got into big current account deficits for some years. Denmark also had a tendency for these current account deficits but they started to correct the system earlier in mid-80s which is also an important observation to make. So that's the background and let me now get to the financial systems. So what, here actually we have an interesting difference which I think is a useful lesson which is that Denmark followed the Western European trend of gradually liberalizing the financial system already earlier whereas the other three countries, Finland, Norway and Sweden, pretty much kept trying to keep the tight controls on credit and banks until 1980s. So Denmark had this and they avoided a system that they had banking problems, some banking problems but no systemic crisis in Denmark. So that's one lesson by the way. As I said, there were tight interest rate controls by the central bank, credit rationing and planning, you know, more or less tight planning of credit flows in the economy by central banks. The banking systems in Finland, Norway and Sweden, so I'm now excluding Denmark mostly for my discussion, were dominated by a few large banks and there were then many smaller banks, savings banks and these were mostly private ownership, under private ownership. There were some then government owned banks but mostly private ownership and capital for the banks was raised from the private sector. The banks carried out in practice the rationing, rationing of credit to households and firms under the tight monitoring by the central bank. Exchange rates, you know, this was very much first the Bretton Woods then after that pegged exchange rate to currency baskets. Tight capital account controls were in place in the 70s and 80s. There were long-term capital movements required permits and they were not necessarily easily granted. No short-term financial movements were allowed. The trade finance as I mentioned was relatively free already from late 1950s and even foreign exchange for travel was rationed. I remember when I was a young man, my first trips abroad, I had to get a permit from the Bank of Finland to get some, you know, relatively small sum of money in foreign currency when I went on my trip. The non-bank part of the financial system was small so there was obviously a stock market, bond markets. There was also an insurance sector but they were kept small and there were no major non-bank intermediaries except some special finance companies and basically no activities of foreign bank banks. Supervision was a very traditional sort of way focused on compliance aspects in lending and accounting and so, you know, no fraud, et cetera. There was no risk supervision basically. This was sort of a traditional accounting legal, legalistic supervision activities. As I said, regulated interest rates so that restricted competition. So banks had to compete in some ways. These were private banks and there was kind of a market there so what they tried, they tried to provide all kinds of services and new branches and so forth even though these were regulated but not so tight. Also there was no, these foreign banks were not allowed to establish subsidiaries there. Of course the legal system in the Nordic countries was quite strong so there, you know, bankrupted procedures, et cetera were in place in place there. This overall created a very stable banking system. The loan losses were small and non-existent, no crisis with them in the tightly regulated area. Obviously these were inefficient banks. There was large personnel, extensive branch networks and so forth which turned out to be quite costly and which had to be wound down to a large extent or reduced when the crisis broke out. And it's of course these tight controls protected independent monetary policy despite fixed exchange rates. You have to remember that the fixed exchange rate in principle you don't have independent monetary policy but if you have tight controls you do and so that was also the traditional mode. Then came the deregulation era and the starting point of that was really the fact that as the countries grew rather well in line with Western Europe and in some cases like Finland catching up with Western Europe, the economy became more international. There was more international trade, firms became international and so forth. So that was one part of the story that the countries, especially the big firms became international that created pressures to liberalize. There was also of course the international organizations IMF, OECD and EU also sought liberalizations of markets and also capital flows. And over time, especially in the 70s and beginning of 80s, leakages and loopholes to these financial controls emerged there. Various kind of form of gray domestic financial intermediation started to appear. Again, the country experience is somewhat different but for example in Finland what happened was that we had a fairly extensive trade with Soviet Union and in fact that of course is not a convertible currency but then what happened was the two central banks, the Bank of Finland and the central bank in Soviet Union had clearing accounts. So they basically, the payments for example for Finnish exports were made to the clearing account in Moscow and then that came into a corresponding balance in the Bank of Finland and then the Bank of Finland paid in Finnish currency to the companies, for their exports. But you have to remember that also the Finnish currency had capital controls and in fact this trade became bigger and was fairly profitable. So the companies had to ask what would we do with these extra funds? We can move them abroad, we can't invest in abroad. If we have spare funds, which after our own real investments, then they started to put them into this gray system. So that was one example of why this gray financial intermediation inside these countries developed. And then because of these leakages and loopholes and this tendency to go for a more open financial system internationally, the liberalization processes were started in the 1980s. And that involves a lot of individual acts. Here's the example, a timeline for Finland. I'm not gonna go, you can't even probably see it, but you can look at the slides afterwards. Basically the liberalization process was viewed as small steps, a large number of small steps going on. So if you've read the details, the big parts here are basically it's 1986 onwards. You can see that the pace also to some extent tightened. Here you start to see a freeing of capital movements in the international part. And here you also see that the interest rate controls were abolished, et cetera, on the domestic side. So this was the way it was also viewed apparently in the Bank of Finland. I was not in the Bank of Finland at that time. So that's part of the story. So let's start to discuss what the problems in financial deregulation are. So the first thing to realize in financial deregulation is that's gonna impose new constraints on the macroeconomic policies. If you realize the financial system, and in particular the foreign aspects of it, the leeway of domestic macroeconomic policies is limited. There is what's called the impossible trinity, which is that with free markets you cannot fix the exchange rate, domestic interest rates and quantity of finance, which you could do under Russian system. And so that is you have to let something go there, something let go there. So that's an important thing to realize in deregulation. And that fact was not necessarily fully appreciated at the time. Then there are a whole lot of questions you have to ask also, of course. One is that what's the order of liberalization? Do you go for the domestic liberalization first or the international aspects? Usually one goes for domestic liberalization first and then international aspects, capital movements, but you could in principle go the other way. And obviously you have to then more specifically ask for specific markets in the financial system in which order do you liberalize them? These markets differ in terms of the asset, in terms of maturity, what sectoral finance derivatives, et cetera, you have to go through all of these as well. All of these as well here. So that's another important issue in liberalization. What about currency denominations? Do you go for domestic liberalization in domestic currency or foreign currencies and also about exports and imports of capital? Which order do you do these things? And then also, what if you get into difficulties? Is it possible to respond to pressures and can you perhaps even reverse that? You see what happened in the Nordic countries, as I showed you, it was a long process but it concentrated on the second half of 80s in Finland and similarly for Sweden, Norway a little bit earlier and Denmark as I said is a different case. They turn out in the end, they liberalized both the domestic system and the currency markets and capital movements more or less in tandem in a relatively short period. And one other aspect which is worth emphasizing is that you have to decide possibly about changing the taxation of finance. Are you gonna favor debt financing by the tax system? Is that gonna be continued or not? In for example, in the case of Finland they did not do anything with that. So we ended up with various problems in the Nordic liberalizations and let me discuss those next. First of all there was bad timing, especially for Finland and Sweden. The big steps as I said were done in right at the start of second half of 1980s and then the business cycle suddenly turned upward internationally. A part of it was the breakdown of the old cartel. For Norway of course that meant the recession and Carinthogan deficit so that's a different development. But they were lucky, in the case of Finland and Sweden a big boom developed as a result of these deregulations and the international upswing in the business cycle for Norway as I said they had a recession, Carinthogan deficits and that cut that boom short. And so for Finland and Sweden, the boom led into a systemic banking currency and economic crisis at the start of 1980s. Finland, there were some special features. One was the fact that for Finland there was also the collapse of the Soviet Union in the beginning of 1990s which was a big shock to Finnish exports so that was an additional fact that that was not present in the case of Sweden. I mentioned Norway, they had less of a boom. They had a major banking crisis though so but I'll come to that in a moment. Denmark had some isolated banking problems but no systemic crisis. So that's the setting. So the timing turned out to be wrong. And as I said Denmark was lucky, they did it more gradually as part of the European process which on the whole was relatively problem free. The other things were, as I said, this deregulation was perceived as a number of steps in these steps of little acts of liberalization, that focus clearly was insufficient. There should have been better guidance to banks, other firms and markets about that the regime is going to change. You're going to change from ration system to a relatively free market where there's going to be competition with flexible prices. And that's a big change for this because there was little realization that this liberalization to market-based finance is going to change the risk setting for banks and even firms and even households. You know risk management viewpoint really became important especially for banks and that was not perceived early on enough. And similarly in financial regulation that was not realized. It continued to be compliance regulation. And in macroeconomics, the countries tried to held on to the fixed exchange regime and that turned out to be problematic with free capital flows. And in the 90s there was a movement to flexible rates and adoption of inflation targeting. So the lessons are basically this financial knowledge is actually very important. You have to realize that if you go from ration systems to market-based finance, that is a new way of thinking. Traditional ways of thinking can be a trap and the reform is much more than just technical lifting of controls. The big question is, do you go for gradual approach or a big bang? Mostly it's recommended to have a gradual approach but big bang can work. Market attachment UK show that you can do things almost overnight in the foreign, they liberalized capital control, capital movements overnight pretty much. And then this timing is quite an important issue in here. And you have then macroeconomics, you have to realize why I already said the impossible trinity, also the taxation issues. And certainly I believe that the flexible exchange rate regime is worth having before you start to open the capital movements. Otherwise you run into problems like the Nordics did. There are benefits to this but there are also limits, I think. I think, but let me not get into that. That's a big subject on its own. So in the Nordic country, we had a financial crisis as we saw it. And here are some slides about that. So here are, I showed the real economic developments earlier. Here are some financial aspects. So here are real house prices in the four countries. And you can see that especially in Finland and Norway, in Finland, for example, in 10 years real house prices doubled. That's the blue line there. And then in the course of the first half of 90s, they almost came back to the old level. Not quite, but almost. That's the blue line. Norway also had a big rise in house prices and a big decline. They came down even to the 1980 level. Sweden, Lesso and Denmark. So there are some differences there. Here's the share prices. Share prices. And so the important part is this period here. This is of course the IT boom. So you should not look at that too much. Too much so here. But again, you see that again, big boom for Finland in share prices. Also for Sweden, these of course, where countries we'd had Nokia and Ericsson, respectively, and had a fairly big IT sector. Lesso in Norway, they had much less of IT at that time. Here's bank lending growth. You can also see that in the second half of 80s, a little bit earlier in Norway, there were big increases in bank lending and then negative lending growth, especially for Finland and Sweden, for about three years or so. And loan losses for banks. These are, you can see these are, again, the crisis period there and operating profits also turned negative in this part. So the crisis management, I don't have time to go into details of the crisis management, but there were also some interesting lessons. In the case of Finland, for example, there was no legislation how to handle financial crisis. So when it erupted in this one bank, Skopbank, which was the sort of central bank for the savings bank system, the Bank of Finland had to take directly over. You had to take over it and get by the old shareholders out. And then things started to happen. Then government set up a crisis management agency and various steps were introduced. One interesting feature is a bit of a novelty here, is that we have to recapitalize the banks in the case of Finland. There was some nationalization. The savings banks eventually had to be nationalized and actually split and reasonable parts sold unless others became losses. But for the other banks, Finland used something called preferred capital certificates to finance them. So these were instruments which were, it was like alone, but it could be counted as capital because they would turn into shares if not repaid in five years. So that's actually similar to what the tarp scheme in the US used eventually. There were guarantees and so forth as well. So, but it took quite a long time. The Finnish banks became profitable in 96 already. There was, as part of that, there were restructurings of banks. Savings banks disappeared largely with a few small exceptions. There was also a merger of the commercial banks, so forth. The staff in the banks was basically halved in five years. Branches were closed and so forth. So big restructuring was done there. Sweden, you know, a somewhat similar story. Let me not get into the details. They also said, they also did not have the legislation for crisis resolution agency, but that was already set up and public support criteria, which strict criteria also introduced. And so, and Norway, Norway had, they in fact had private guarantee funds for the banks and they were used, but they were not sufficient and they were exhausted. So the government had to set up a guarantee fund and a crisis management agency for this. And then, remember, they didn't have a big recession, but they had a big ranking crisis. And then they actually took a very fairly radical step in the early 1992. They nationalized the biggest problem banks, including the biggest, three biggest commercial banks were nationalized. The old shareholders were wiped out. These were taken over by the government because the government basically said, these are bankrupt banks, we will take over and the shares are gonna be well. And so, they in fact then had an issue that the government became an owner of the banks and that's not an easy situation either if you have banks in the market system and how to run them, how to keep a reasonably level playing field against the non-nationalized banks with the non-nationalized banks, et cetera. But they sold them a few years, you know, gradually. The first one was sold about three, four years afterwards and so forth. The interesting thing is this figure which estimates, which provides data, this is not my data, but from a Norwegian publication, the gross fiscal cost and the net fiscal cost in the three crisis. There are of course no unique way to do it. You have to, which baseline relative to GDP you have to decide and then how long a period do you allow for recovering the initial public spending to the banking crisis. But one big lesson is that the net fiscal cost in the longer term is gonna be much smaller. So you can see that in the case of Finneady, basically have, in the case of Norway, the net cost was even negative, slightly negative. They managed to sell the banks at a good price eventually, the nationalized banks. And in Sweden also, it dropped almost to zero according to these numbers, these numbers. So that's, you know, the government can, they will acquire assets when they manage the banking crisis. And then it's a question, how do you sell them? How do you sell them? Obviously, how do you acquire them, but how do you sell them eventually and don't sell them necessarily too quickly? It's a difficult decision to make, but that's what this tells it, the net fiscal cost is quite a bit lesser. So let me then conclude with some general lessons from the crisis management part of it, which is obviously the first lesson is that prevention of the crisis is a big priority. As we saw, especially Finland and Sweden, the financial crisis can be very costly if it's a major financial crisis. It's not easy to diagnose the overheating situation, but there are some hints there, which you might want to look at. The crisis management part is if it comes to that, you know, obviously the first thing you have to do is that you have to maintain confidence in the banking system. The banking system, obviously nowadays, the banking systems are quite complex. They were simpler then, but there are two basic things which are important for the society of the banks. One is, of course, is the fact, is the ordinary lending and financial intermediation for standard loans to businesses and households. If that breaks down, then things are gonna be. And the other one is the payment system. If the banks really get into difficulty so that nowadays, of course, you know, certainly in the Western world, it's electronic payments. If that got into difficulties, then that would quickly bring the economy to a standstill if you can make payments through the banking system. That's their responsibility. So that is, that's an important starting point. And then it's, you know, in the Nordic countries, there was broad political support, was obviously debates at first, but eventually that came and relatively quickly. And then there were guarantees to banks' obligations in Finland and Sweden. Norway did not provide a general guarantee, but they made very specific statements to that aspect. This can be problematic if the banking crisis gets even bigger than the Nordic crisis, as we've seen in the Irish case, for example, now, or the Icelandic case where they did something else. The central banks, obviously, liquidity support, keep the banking system running, is quite important. We, the Fankö Finnen had a special problem which was the fact that there was no legislation. You had to directly take over a bank and put in new management to run it. The two agencies are important, crisis resolution, so the Ministry of Finance has to take overall responsibility here, and they have to guide the restructuring of the banking system, et cetera. And also, the government will acquire assets when handling this crisis. So asset management companies need to be established and to deal with these non-performing assets, and that's also something that was well-learned, I think, in the Nordic crisis management, and you want to keep it separate. You let the professionals run the asset management companies and then you have this issue, what do you do with the assets in the longer term? How do you sell them? What time horizons do you have, and so forth? And I think, as I said, the Nordic countries, even though they are often considered to be role models, the deregulation did not turn out well, as I've been telling you, but the crisis management has been a better story. So these steps here, that you have to restructure the banking system, make it more efficient typically here, you will need a fairly independent government agency to deal with this process, and you also need the asset management company, and the fact of general toughness with the banks and timely action. Clear, transparent, timely action is very important in managing a financial crisis, and I think these were some of the lessons that were learned from the Nordic crisis. Thank you.