Finland: Arsenal

The Buildup

During the 1980s in Finland there was a large-scale deregulation of the financial sector as outlined in Figure 1. The government allowed banks to lend into areas where they had not lent before and therefore lacked market-specific knowledge. Regulatory decisions were subject to court challenges, and it has been theorized that this “raised the threshold for introducing stricter supervisory practices” (Nyberg and Vihriälä 1994). In addition, regulators lifted strict limits on deposit and interest rates. More broadly, the supervisory authorities were viewed as relatively weak: “they lacked resources and qualified staff and did not prioritise on-site inspections” (Moe, Solheim, and Vale 2004). The savings banks were taking extraordinary risks and were under-capitalized.

Source: Nyberg and Vihriälä 1994.

During the same time period, both household and corporate debt increased significantly. The Finnish, Norwegian, and Swedish “tax systems encouraged borrowing through very generous rules for deducting interest expenses from taxable income” (Moe, Solheim, and Vale 2004). Household debt rose from 25% of GDP in 1980 to 45% in 1992, and corporate debt rose from 70% of GDP to nearly 90% of GDP in just a couple of years starting in 1989.  Housing prices doubled between 1986 and 1989, and the Finnish stock market tripled in value between 1985 and 1988 (Mayes, Halme, and Liuksila 2001). Commercial property prices may have increased even more than residential prices. This led to the traditional cycle where the increases in property prices lead to higher collateral values, which facilitate an increase in bank lending (Moe, Solheim, and Vale 2004).

In addition, there were two significant international events that affected the Finnish economy in the late ’80s and early ’90s. First, Finland faced significant speculative attacks on its currency, which resulted in a major devaluation in September 1992. In an attempt to stabilize its currency, the Finnish government tightened monetary policy through rising interest rates, which dampened borrowing (Mayes, Halme, and Liuksila 2001).

Second, Finnish exports collapsed with the fall of the Soviet Union (Moe, Solheim, and Vale 2004). The Soviet Union had accounted for approximately 15% of Finnish exports (Mayes, Halme, and Liuksila 2001). The decrease in exports to the former Soviet Union caused a negative demand shock of approximately 2.5% of GDP to the Finnish economy (Nyberg and Vihriälä 1994).

The Crisis

Finland was not alone in suffering a banking crisis and economic downturn during the early 1990s. Sweden, Norway, and Denmark experienced crises that, although they had distinct causes and effects, were similar in many ways. However, Finland suffered the most, with a growth rate of negative 8% of GDP during the worst of the crisis years and a peak unemployment rate at greater than 20% (Mayes, Halme, and Liuksila 2001). See Figure 2.

Source: Mayes, Halme, and Liuksila 2001.

Outstanding loans to the public by all Finnish deposit banks had more than doubled from FIM 214 billion to FIM 491 billion from 1985 to 1990 (Nyberg and Vihriälä 1994). Throughout the time period, GDP was growing at a similar pace, so this lending represented a consistent 75% of GDP (World Bank n.d.). Then, from 1991 to 1995, bank lending fell by more than a third. It would take nine years before bank lending returned to the pre-crisis levels (Moe, Solheim, and Vale 2004). This dramatic buildup and then crash of the banking sector can be seen in the two charts in Figure 3, which show the decrease of employment in banking by more than half and, similarly, the closure of more than half of physical bank branches. By 1993, nearly one in five loans were non-performing (Klingebiel 2000).

Source: Mayes, Halme, and Liuksila 2001.

Summary of Finnish Government Actions Leading up to Arsenal

Skopbank was one of the banks that most embodied the increase in volume and expansion into new sectors of lending during the late-1980s boom years. It was a commercial bank that served as a central bank or correspondent bank to Finland’s savings banks. Skopbank was one of the first institutions to face imminent collapse as the market began to sour. In addition to being one of the most aggressive lenders during the “boom years,” Skopbank made a large, strategic investment in a multiproduct industrial group that fell sharply with the turn in the market (Nyberg and Vihriälä 1994). Skopbank was controlled and mostly owned by the savings banks (Borio, Vale, and von Peter 2010).

In 1989 the Bank of Finland, Finland’s central bank, and Finland’s Banking Supervision Office, an arm of the Ministry of Finance, began a “special and increasingly strict surveillance” of Skopbank’s books (Nyberg and Vihriälä 1994). In October 1990 a restructuring program was designed by the authorities that required that the savings banks raise FIM 1.8 billion in capital from private investors for Skopbank. Ultimately, however, the capital proved insufficient, and after an acute liquidity crisis in September 1991, the Bank of Finland took majority control of Skopbank, with 53% of the outstanding shares (Borio, Vale, and von Peter 2010); recapitalized the bank with an initial investment of FIM 4 billion in equity; and set up three companies to manage most of the bank’s assets. This takeover and equity injection were seen as outside the traditional roles of a central bank (Nyberg and Vihriälä 1994).

In March 1992 the Finnish government provided an FIM 8 billion capital injection program to the banking system. Participation in the program was voluntary, but “virtually all banks applied and received a share” (Moe, Solheim, and Vale 2004). The capital was available to “all banks regardless of their solvency and in relation to their risk-weighted assets.” By December 1992, FIM 7.9 billion of the FIM 8 billion program had been deployed (Nyberg and Vihriälä 1994).

In late April 1992, the Parliament created the off-state-balance-sheet Government Guarantee Fund (GGF) (Parliament of Finland 1992) to prevent a collapse in domestic and international confidence in the stability of the banking system and its claims. The GGF was initially provided with FIM 20 billion in federal funds to use to meet that stated goal. However, by the end of the year, three quarters of the money had been spent. In early 1993, another FIM 20 billion was made available (Nyberg and Vihriälä 1994). One of the first actions of the GGF was to acquire Skopbank from the Bank of Finland.

Another significant action taken by the GGF was the June 1992 decision to force the merger of 41 of the country’s 81 savings banks into a new entity called the Savings Bank of Finland, or SBF. SBF accounted for 23.9% of the total financial system’s assets (Klingebiel 2000). The GGF provided the new entity with an initial commitment of FIM 7.2 billion, including FIM 5.5 billion in Tier 1 capital and a guarantee for a FIM 1.7 billion subordinated loan. This original amount proved insufficient, and multiple rounds of further assistance were required. By October 1993 SBF had received a total of FIM 14.5 billion. At that point, the GGF sold the healthy parts of SBF, about FIM 41 billion in assets (Nyberg and Vihriälä 1994), to four competing banks: Kansallis-Osake-Pankki, Union Bank of Finland Ltd, Postipankki Ltd, and the Okobank Group (Bank of Finland 1993).

Financing and Governance of Arsenal

On November 18, 1993, after FIM 41 billion in healthy assets of the Savings Bank of Finland  were sold to four large commercial banks, an asset management company called Arsenal was formed to handle the remaining FIM 30 billion in unhealthy assets (Nyberg and Vihriälä 1994). The new venture was funded by the Government of Finland (Government) and the GGF (see Figure 4). In the initial FIM 5 billion capitalization, the Government took a 74% equity stake and the GGF took 26% (Arsenal 1994). Due to higher than originally anticipated losses, the Government made a series of further capital injections: FIM 6 billion in 1994, FIM 8 billion in 1995, and FIM 4 billion in 1996 (Borio, Vale, and von Peter 2010). The equity balance ultimately shifted slightly to 79% and 21% for the Government and the GGF, respectively (Klingebiel 2000). See Figure 4 for a visual representation of Arsenal’s financing.

Sources: Klingebiel 2000; Borio, Vale, and von Peter 2010.

Coupled with the FIM 23 billion in total state-injected capital, Arsenal also received an unconditional guarantee from the Government of up to FIM 28 billion for all “repayment of bonds and other debt financing issued by Arsenal” (Arsenal 1994). The bonds were described as “negotiable, State-guaranteed zero-coupon bonds in the form of a book-entry security and technically comparable to certificates of deposit issued by commercial banks and governments” (Arsenal 1995). Most of the debt had short tenures. However, in 1996, two long-term bonds, worth a total of FIM 3 billion, were issued (Arsenal 1996). In its first series of public debt issuances, Arsenal sold FIM 20.6 billion (Arsenal 1994). The amount of debt issued is outlined in Figure 5.

Sources: Arsenal 1994; 1995; 1996; 1997; 1998; 1999; 2000.

The governing structure of Arsenal was designed with a balance of private-sector expertise and Government oversight. Of the six members of the board of directors, two were from the private sector and four represented the Government. The CEO and other senior management members were appointed by the Government from the private sector. Oversight of Arsenal was conducted by the GGF, the State Audit Office, and the Parliamentary State Auditors (Klingebiel 2000).

Operations and Assets

Arsenal became operational on January 15, 1994 (NAOF 2015) and began the process of assuming responsibility for the assets the following month. At the outset, the Government estimated the time horizon within which Arsenal would be able to divest its assets was five to seven years. However, it was noted that, “the divestment process will possibly continue after year 2000 if it will assist in reducing the financial burden levied on the Government” (Arsenal 1994).

The non-performing assets acquired by Arsenal were taken at book value. Given the market turmoil, it was widely accepted that the book value was substantially higher than the market value. This was confirmed in the summer of 1994 when an extensive review was conducted by external surveyors to assess the market value of the complete real estate portfolio. Based on the estimates, property write-downs amounted to FIM 3.5 billion during 1994 (Arsenal 1994). The portfolio included loan receivables, real estate, and other assets totaling a book value of FIM 30 billion (Nyberg and Vihriälä 1994). This included 15,000 properties and 1,478 companies, of which 95% were real estate companies (Arsenal 1995).

Assets originally transferred accounted for 5.2% of Finland’s total banking assets and 8.2% of GDP (Klingebiel 2000). In addition to the original assets, Arsenal was permitted by law to extend additional credit as needed, “in cases where this reduces the total cost to the Government” (Nyberg and Vihriälä 1994). Also, the four banks that had acquired the healthy assets of SBF were permitted to transfer to Arsenal any of those assets that underperformed or became non-performing until the beginning of 1995. Those banks transferred an additional FIM 10 billion during 1994, bringing the total assets of Arsenal up to FIM 40 billion (Bank of Finland 1994; Arsenal 1994).

Arsenal’s largest asset disposal of 1995 was the sale of a travel resort, and in 1996 it was a golf course (Arsenal 1995; Arsenal 1996). Although Arsenal did not commence any new construction projects, it did manage unfinished property developments if it was determined that, “the overall result is better than through selling the unfinished project” (Arsenal 1994).

Expansion to Asset Management Group

Arsenal began as an asset management company with the sole purpose of managing and liquidating the non-performing loans and other assets of the SBF. However, during the years following its creation, Arsenal’s purpose was expanded to absorb more troubled institutions and assets.

In the summer of 1993, the GGF split STS Bank, a small, struggling commercial bank, into two entities. The entity with healthy assets was bought by KOP Bank, a larger bank. The entity with bad assets was renamed Siltapankki, and although officially owned by KOP Bank, control of Siltapankki was held by the GGF. In November 1995 Siltapankki was sold to Arsenal for only FIM 1 (Borio, Vale, and von Peter 2010).

In June 1995, the law was changed to allow Arsenal to expand to hold other asset management companies. When Arsenal was originally founded, there were certain assets of SBF that had not been transferred to Arsenal itself, but rather had been kept as a subsidiary bank of Arsenal. In November 1995 the banking charters of this entity (named Arsenal–SSP) and Siltapankki (renamed Arsenal–Silta) were revoked, and both entities became asset management companies (Arsenal 1995).

The Bank of Finland (the central bank) took over Skopbank, the correspondent bank of savings banks, in September 1991. It divided the assets into three holding companies, one of which was a real estate asset management company called Sponda (Bank of Finland 1991). In May 1996, with real estate assets worth FIM 1 billion, it was sold to Arsenal (Kuusterä and Tarkka 2012, 694).^FNThe other two holding companies were named Scopulus (which held the shares of Skopbank itself) and Solidium (which held industrial assets) (Nyberg and Vihriälä 1994). Scopulus sold its shares to the GGF in June 1992. Solidium was merged into Sponda before Sponda was sold to Arsenal (Kuusterä and Tarkka 2012, 675).^FNNote that on page 1 of the Arsenal 1997 Annual Report, the entity is called SKOP-Real Estate.

Wind-Down and Liquidation

In 1996, the number of debtors being managed by Arsenal Group peaked at 1,584 (Arsenal 1996). At its height, as seen in Figure 6, Arsenal had a total of 630 employees in 1995 (Arsenal 2002). By 2003 there were just 13 salaried employees (NAOF 2015).^FNThe company also had two liquidators. In 1997 the number of offices was reduced from 22 to 15 (Arsenal 1997) and then from 15 to 6 in 1999 (Arsenal 1999). See Figure 6 for a representation of these changes.

Source: Arsenal 2002.

As seen in Figure 7, more than 90% of the peak total assets had been offloaded by 1999 (NAOF 2015).

Source: NAOF 2015.

Arsenal was placed in liquidation in October of 2003. The duties of the board of directors and managing director were transferred to two liquidators who oversaw a reduction of outstanding debtors from more than 1,500 to less than 500 between 2003 and 2014 (NAOF 2015). According to Arsenal’s 2017 Financial Statements, the most recent available at the time of this writing, the liquidation of Arsenal was ongoing, but it was estimated that by the end of 2018 there would be only one employee. There were a number of Arsenal assets that were going through domestic or foreign bankruptcies. These were expected to close within two to three years, at which point Arsenal was expected to dissolve (Arsenal 2017).

As seen in Figure 8, Arsenal lost nearly FIM 20 billion in the first five years of operation (Arsenal 1994; 1995; 1996; 1997; 1998). During the next four years leading up to the liquidation, Arsenal turned a small annual profit (Arsenal 1999; 2000; 2001; 2002). At the time of liquidation the cumulative losses stood at FIM 19.07 billion.

Sources: Arsenal 1994; 1995; 1996; 1997; 1998; 1999; 2000; 2001; 2002.

The approximately FIM 114 billion cost of the rescue of Finland’s financial system has been estimated at 17.2% of GDP by 1995. Of this 17.2%, studies have estimated that more than half of the Government’s investments were recovered, making for an estimated net cost of about 7% of GDP (Mayes, Halme, and Liuksila 2001). The funding for Arsenal itself was estimated at 6.6% of GDP (Borio, Vale, and von Peter 2010).