Johnsen underscored the seriousness of the potential consequences for the Norwegian economy if the Government did not intervene resolutely in the crisis: 9 “The gravity of the situation is simply this: A collapse of the banks will also break the backbone of the Norwegian economy. If we do not implement extensive measures now, a good many ordinary people may lose their savings.” But the Minister of Finance made an important reservation. In the same account, he also stated that the banks’ owners could not expect to escape unscathed: “At the same time, the instruments are designed so that banks themselves will have a principal responsibility for solving their financial problems. They will not simply be able to send the bill for their misjudgements to the government.” That was also the case in practice. The shares in banks that lost all their equity capital were written down to zero, in line with the principles pertaining to the bankruptcy of other enterprises. The capital injections banks received were made on the condition that they restored order to their organisations while cutting unnecessary costs. In other words: we bailed out the financial system, but not the banks’ owners. On the other hand, practically no creditors lost their assets, even in the banks that had lost more than their equity. Creditors were bailed out through the government’s recapitalisation of the failed banks. In the aftermath of the crisis, the Banking Law Commission was tasked with drafting a new law on crisis resolution.
BIS central bankers’ speeches  3  When the government assumes a substantial portion of bank risk in this way, a problem arises that we economists refer to as moral hazard: If there is a widespread perception that the authorities in reality stand behind banks, banks may take insufficient account of the risk of losses when making decisions. In particular, the risk that things can go horribly wrong may be underestimated, because banks do not have to bear the consequences of a crisis. By bailing out banks, we in turn reduce the motivation of banks’ owners and creditors to take full account of the risk associated with their activities. The pricing of risk is easily set too low. Banks may therefore end up taking excessive risk. Now, the authorities that bail out banks will often require that the former owners forfeit their equity. This means that bank owners should, at the outset, have incentives to hedge against the risk of large losses. But owners’ risk is limited. It does not cover losses beyond paid-in capital. Owners’ motivation to avoid risk may therefore be weakened at a bank with little equity. The lower the equity capital is, the more serious the problem of moral hazard becomes. An interesting feature of the financial crisis was precisely banks’ low pre-crisis equity ratios. Many large international banks operated with equity of around three percent of their total portfolios. 8 This means that for every dollar or euro the banks owned they invested thirty.