A financial crisis means that the financial system is unable to fully provide any of its fundamental functions – the mediation of payments, the conversion of savings into funding, and risk management. Any crisis in the financial system is serious and may lead to economic decline, bankruptcies and unemployment. It often takes a long time for the economy to recover, and it is not certain that the losses can be entirely recouped. It is therefore important to reduce these economic costs by exercising good crisis management.
From the Riksbank’s point of view, crisis management is one part of the task of safeguarding financial stability. The Riksbank’s crisis management can be divided into three areas:
- supplying liquidity to the financial system,
- communicating the Riksbank’s assessments openly and in contacts with market agents,
- cooperating with other authorities in Sweden and abroad.
Being able to manage a crisis requires the Riksbank to produce on-going, high-quality stability analysis that provides a sound understanding of the financial system. The Riksbank must also maintain its practical ability to manage crises even when conditions are normal. This includes well-prepared routines for decision making and agreements and routines for how different authorities should cooperate during a crisis. It also includes regularly testing regulations, routines and the cooperation between authorities, as well as crisis-management training for personnel. The Riksbank regularly conducts crisis management exercises, both internally and together with other Swedish authorities and stakeholders in the private sector. The Riksbank has also conducted a number of crisis management exercises with overseas authorities.
Supplying liquidity
In a crisis, liquid funds are often in short supply. Important financial markets may work ineffectively, while the liquidity in the financial system may not be distributed normally due to uncertainty and a lack of confidence. In such a situation, the Riksbank has several ways of quickly adding liquidity to the system. These differ depending on whether it is a case of providing liquidity assistance to single institutions or general measures to strengthen liquidity.
The Riksbank can provide liquidity assistance to individual institutions under special conditions. The aim of such assistance is to prevent a situation in which a solvent bank is forced to suspend payments and to prevent the effects of such an event from spreading throughout the system. These special conditions may, for example, include the Riksbank accepting forms of collateral other than those that normally apply to the Riksbank's lending. Banking institutions and Swedish companies that fall under the supervision of Finansinspektionen may receive such assistance under exceptional circumstances. One such circumstance is if the Riksbank believes that the institution concerned is systemically important in the situation at that time. In light of this, the Riksbank provided special liquidity assistance to Kaupting Bank Sverige and Carnegie Investment Bank during the autumn of 2008.
General measures to strengthen liquidity can make the terms of borrowing from the Riksbank more attractive to banks. These measures may take several different forms. During the financial crisis that began in the autumn of 2008, the Riksbank added liquidity to the system by:
- offering loans in Swedish kronor at longer maturities than normal,
- increasing access to loans, for example by accepting more types of collateral than previously and widening the circle of financial institutions permitted to borrow from the Riksbank,
- offering loans in other currencies.
See also Financial turbulence – the Riksbank’s response (link below), which includes all details of the Riksbank’s lending activities during the crisis.
Communication and contacts with market agents
In a crisis, the Riksbank constantly communicates with the market agents and discusses the seriousness of the situation and appropriate measures with them. In this dialogue, the market agents also inform the Riksbank of how they perceive the situation in their own companies and, more broadly, in the financial system. The Riksbank may also be called on to assess the systemic importance of a bank, for example, at very short notice. Consequently, under the Sveriges Riksbank Act, the Riksbank also has far-reaching powers to require the information it believes necessary from companies that are subject to the supervision of Finansinspektionen.
Cooperating with authorities and other central banks
The Riksbank shares responsibility for mitigating the economic effects of a crisis with other authorities. Finansinspektionen is responsible for supervising the financial companies. The Riksbank is responsible for maintaining liquidity in the system. The Swedish Government and the Swedish National Debt Office, as a supporting authority under the Support to Credit Institutions Act, have a responsibility for more long-term forms of support. This may include, for example, guaranteeing the banks’ long-term borrowing or injecting risk capital.
According to the Support to Credit Institutions Act, support may only be given to credit institutions that are judged to be systemically important. The cooperation between authorities in Sweden is regulated, for instance, in a written agreement, what is known as a Memorandum of Understanding (see link below).
Increased internationalisation makes greater demands for central banks in different countries to cooperate on crisis management. The cooperation between authorities in different countries is also regulated by Memo¬randums of Understanding (see the link below). Within the EU there is an overall agreement on cooperation on cross-border issues. Under the umbrella of this, the Ministries of Finance, central banks and financial supervisory authorities in the Nordic and Baltic countries have signed an agreement on more in-depth cooperation to manage issues relating to cross-border financial stability and crisis management in the region. Moreover, the Riksbank has separate agreements with the central banks in the Nordic and Baltic countries respectively regarding cooperation in the event of problems in a cross-border bank.
The central banks also cooperate by lending money to one another and thus contribute to mutual macroeconomic and financial stability. For example, during the recent financial crisis:
- the Riksbank offered short-term funding through swap agreements to central banks in neighbouring countries to make it easier for them to take measures to stabilise their own financial systems (see link below).
- the Riksbank entered into swap agreements with the US Federal Reserve and the ECB, which gave the Riksbank the possibility to borrow US dollars and euros to maintain the Riksbank’s capacity to act as lender of last resort in foreign currencies.