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'No bank should be promised eternal life'

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'No bank should be promised eternal life'
Øystein Olsen making a speech in Oslo in December. Photo: Nils S. Aasheim/Norges Bank
11:12 CET+01:00
The governor of the Central Bank of Norway (Norges Bank) has called for his country to intensify reforms so that the country's taxpayer will not have to bail out its banks in a future financial crisis.
"No bank should be promised eternal life," Øystein Olsen said in his annual address on Thursday, as he called for a new national agency to be set up to deal with distressed banks.
 
"A market functions best when there is scope for new entrants and for the closure of loss-making companies. The same applies to financial markets." 
 
Norway's banks escaped the 2008 financial crisis unscathed, partly as a result of the reforms that followed Norway's major banking crisis from 1988 to 1993, which saw two out of the country's four largest banks lose all their capital. 
 
Olsen conceded that bail-outs were sometimes necessary, but warned that they created additional risk. 
 
"It may be necessary to provide support to banks in distress. But it comes with a major drawback," he said. "Banks will also expect support in the future, which is a source of moral hazard." 
 
Olsen said that the problem was less about morals of those working in banks than about incentives, with banks' creditors starting to charge lower interest rates to banks on the expectation that if anything goes wrong they will be bailed out. 
 
"This leads to the underpricing of risk, which may in turn lead to excessive risk-taking in the banking sector," Olsen concluded. 
 
He called for banks to draw up "living wills" on how they should  be treated in the event of a crisis, and argued that distressed banks should be dealt with by the Ministry of Finance rather than the National Bank.  
 
"A separate national authority to deal with distressed banks should be set up," he said. "It should be created as a unit in the Ministry of Finance and this is no natural task for a central bank." 
 
Olsen also called for the country's sovereign wealth fund -- the world's largest -- to take on more risk, cutting its bond investments from 40 percent to as little as 20 percent of its portfolio,
 
"To achieve returns, we must take on risk," he said. "The fund features a very long investment horizon and a sizeable capacity to bear short-term risk. If we can exploit these distinctive features when making investment choices, it should be possible to obtain a return in excess of average market return." 
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