The Swedish model for Europe’s bail-out

The European banking sector is under extreme stress. As fears grow about the sustainability of Greek public finances, banks with large exposures to Greek bonds are under increasing pressure. The situation is not beyond recourse, however. Through co-ordinated European and national policies, progress can and will be made.

The immediate need to strengthen the fiscal position in some euro-countries should be handled primarily in the eurozone. But the banking crisis requires a common solution for the entire European Union. The single market, including the common and integrated market for financial services, is a core achievement of the EU. Only an EU-wide legal and institutional framework can make markets work in the interest of all Europeans. We have a European, not a eurozone banking system. So we need to find a European solution.

The challenges to secure financial stability and restore market confidence are similar to what Sweden faced during our banking crisis in the early 1990s, but on a European level. At worst, non-performing loans in Swedish banks amounted to more than 12 per cent of gross domestic product, and five out of seven major banks received government support.

We learnt the importance of restoring confidence and that capital injections are vital – if necessary with government money. Based on our experiences, we believe several steps are needed. The size of the problem must be addressed directly and openly. Hence, the European Banking Authority needs to carry out a credible and rigorous stress test identifying which banks need capital injections. Troubled banks should be subjected to a deeper third-party assessment, like the one BlackRock performed in Ireland.

Then, identified problematic banks have to raise more capital, preferably by private capital injections. When this is not sufficient, and as a last resort, public capital injection should be used. Such injections should primarily be made nationally. But as the crisis does not respect national borders this has to be complemented with a European response – a pan-European backstop at the level of the EU27.

To gain credibility from the markets and be accepted by our citizens, such a backstop needs to be guided by four principles. The purpose is to safeguard the financial system, not shareholders. Bank share purchases should be based on conservative market prices reflecting the value of the failing bank in the absence of support measures, with “haircuts” if necessary. Prices should be determined after due-diligence from a third party. Second, when taxpayers risk their money, they should receive the potential upside of the investment. This is vital in mitigating moral hazard.

Third, public capital injections warrant public control of bank management, including strict control of dividend policy, bonuses and salaries. This is vital to deter dangerous risk-taking and to ensure public support for using taxpayers’ money. Fourth, the backstop should operate at arms-length from national governments without political involvement in commercial decisions.

European leaders must now move quickly to find credible and sustainable solutions to the ongoing economic and financial turmoil. These solutions must be European in scope and contribute to broad political backing throughout the EU.

So, the commission’s proposal to introduce a financial transaction tax should be postponed or abandoned. Implementing it solely in Europe would lead to financial activities moving outside Europe. In re-recapitalising and re-structuring banks, we must minimise long-term costs and protect taxpayers’ interests. We need the EU more than ever. A failed and fractured Europe would threaten our prosperity as well as our contributions to global stability. Our task is not to create new divisions in Europe, but rather to demonstrate a new unity.

The writers are Sweden’s minister of finance and minister of foreign affairs respectively