What was the Swedish Banking crisis?
Swedish banking crisis is one of the most well-known financial crises. It occurred in 1992. All through the decade of 80s, the central bank of Sweden kept interest rates low. Due to low interest rates, demand for loans went up sharply. A large number of these loans were mortgage loans for buying residential and other properties. Demand for real estate, therefore, went up. People borrowed more to buy real estate. This raised property prices sharply.
When the decade of 90s started, the Swedish central bank raised interest rates. This increased the interest payments for borrowers who had taken mortgage loans and other loans. Increased number of borrowers started defaulting on their loans. The properties against which they had taken the loans had to be foreclosed because of these defaults. The lenders brought these foreclosed properties back to the market for sale. This suddenly increased the supply of real estate. This brought a crash in property prices.
Property prices crashed as mortgage loan defaults increased
Now because of this fall in property prices, lenders, such as banks, were unable to recover the amount due to them from delinquent borrowers, by selling these properties. Therefore, write-offs on such loans increased. These write-offs reduced the capital of banks. This triggered the banking crisis.
A number of Swedish banks went insolvent or bankrupt in this crisis. Government bailout had to be given to some of these banks through nationalization. To prevent a run on these banks, the Swedish government gave a guarantee to all depositors that their money is safe. It will be returned by the government in case the banks fail to do so.
A run on happens when all the depositors simultaneously run to the bank to withdraw their deposits because of the fear that the bank will become insolvent. And it will be unable to pay back their deposits. A run on is a common feature of any banking crisis.
Government bailout and cost to taxpayers
The Swedish government also created a “bad bank.” A bad bank is created for buying the non-performing assets of banks and then selling them. Non-performing assets are those loans on which the borrower has defaulted. So Swedish banks that were in trouble sold their non-performing assets to this bad bank. The shareholders of these banks took a loss because of the write – off of loans or because of selling of these loans to the bad bank at heavily discounted prices. Saving the banks from getting shut down through government support cost the taxpayers of Sweden an amount equal to 2% of the country’s GDP then.
A systematic crisis
The crisis was caused because of excessive borrowing due to low interest rates, followed by sudden increase in interest rates by the central bank. There is always the credit risk in any loan, whether it is a gold loan, a business loan, a personal loan, or a mortgage loan. Credit risk is the risk of the borrower defaulting on her interest or principal payments because of some reason or other. The credit risk varies from borrower to borrower. For some borrowers it is higher, for some it is lower. The interest rate that you pay on the loan that you take also depends on your credit risk. When a large number of borrowers default on their loans at the same time then it may cause a systematic crisis, like the Swedish banking crisis.