The crisis in Norway was least severe, even though it preceded crises in Sweden and Finland. Consider the following: in Norway, real GDP dropped cumulatively by 0.1 percent, while in Sweden GDP dropped by 5.3 percent and in Finland GDP dropped by 10.4 percent; Norway’s cumulative fall in bank lending amounted to 4.9 percent, while in Sweden it was 26.4 percent, and in Finland it was 35.5 percent (Sandal 2004). In part, this was because financial liberalization in both Norway and Sweden was less radical than in Finland. Unlike Sweden, however, Norway was not under economic pressure from other sources during the deregulation period. Sweden suffered from lack of exchange rate credibility due to recurring devaluations, high inflation, and a costly, expanding public sector (Ergungor 2007). Norway was lucky to be free from such problems.
The case of Norway is therefore the cleanest to examine first. Financial deregulation in the form of lifting interest rate ceilings and quantitative restrictions occurred in Norway beginning in 1984 (Vale 2004). This was followed by a bank lending and real estate boom, as borrowers who had previously been unable to obtain loans were able to borrow at very low interest rates, particularly between 1984 and 1986. Much of the lending was funded from abroad (Steigum 2004).
As consumption increased, the savings rate dropped. Prices of real estate, particularly non-residential real estate in Oslo, increased greatly until 1986 and then fell through 1992, indicating a real estate bubble (Steigum 2004). Borrowing for real estate loans and other purposes was encouraged by the government’s policy of favorable tax treatment of interest payments. Deregulation also allowed new banks to enter the market, while supervision was reduced from on-site inspection to document inspection (Vale 2004). This led to excessive risk taking and poor managerial control.
External shocks then set in. First, a decline in the price of oil, a major export commodity, led to a fall in asset prices. Bank loan growth subsequently slowed by 1989 (Ongena et al. 2000). Second, in 1990, Norway’s banded peg to the Deutschemark and Germany’s increase in interest rates after unification forced Norway to raise interest rates despite the slow economy (Vale 2004).
During the first part of the crisis, between 1988 and 1990, there were many small bank failures. The first bank to encounter losses was Sunnmorsbanken, a medium-sized bank that was troubled by loan losses (Sandal 2004). The small banks, backed by government guarantees, were merged with larger banks. Deposit insurance was managed by the banking industry itself, which first injected capital into troubled banks (Ongena et al. 2000). At the same time, guarantee funds were depleted due to a worsening position in the large banks, including Fokus Bank, Christiania Bank, and Den norske Bank.
In all three Nordic countries, the government offered assistance and engaged in takeovers. When it was found that Norway’s banking industry facilities had run out of funds to make up for bank losses, the Government Bank Insurance Fund (GBIF) was set up to extend loans to distressed banks. By October 1991, the Norwegian banking crisis became systemic when the second-largest bank lost its equity capital and the fourth-largest bank lost its shareholder capital (Vale 2004). The GBIF was depleted, and the government stepped in and took control of the large failing banks (Ongena et al. 2000). The government was left as the dominant owner of Den norske Bank and the sole owner of Christiania and Fokus Bank. During the Norwegian banking crisis, 13 banks representing more than 95 percent of the total commercial bank assets in Norway either failed or were seriously impaired.
The ERM crisis worsened the Nordic crisis, forcing Norway, Sweden, and Finland to import Germany’s high interest rates and suffer currency attacks. After attempts to defend the currency, in late 1992, Norway abandoned the ERM and the krone was allowed to float. As Norges Bank, Norway’s central bank, brought down interest rates, the economy began to grow again, bringing down loan losses (Vale 2004). The government gradually sold back its bank shares over the following decade and economic recovery was rather swift.