How to leave the Eurozone: The case of Finland

A report by EuroThinkTank presents the general guidelines for an exit by any euro-country but concentrates on the details of the exit process and its costs for Finland. In this blog entry, I go through some of our main findings considering Fixit.

Payments systems: The Achilles heel of Finlands exit

The most serious issue affecting Finlands options in a fast-track exit is that her systems have been almost fully integrated into the euro payment and clearing systems. Her own retail payments system was discontinued in 2014, and the large-value payments system (POPS) is expected to follow suit soon. Because domestic systems have been all but eliminated, exiting the euro would pose a threat of severe payment system failures, greatly increasing the costs of a Finlands exit.

However, this problem could be significantly alleviated at the national level by capital controls, under which all foreign payments would need to conform to rules established by the Bank of Finland. Payments could be handled by commercial banks, but they would be subject to checks and possible sanctions by the BoF and the Financial Supervisory Authority. Finland could thus operate euro-denominated systems domestically and convert foreign payments in the border until accounts had been redenominated to the new markka (from now on NM).

Money and the Bank of Finland

An exit by Finland would need to be supported by strict capital controls, and they should be implemented immediately after the exit decision by the Parliament or, if needed, during the planning stage to control the outflow of capital and deposits. After the parliamentary decision to issue the new national currency as the legal tender in Finland, all banks and financial institutions would be legally obliged to convert all their account euros into the new currency at an exchange rate of 1:1. This would take a considerable amount of time based (from some months to possibly over a year).

New bank notes would need to be ordered immediately after the parliamentary decision. The issuance of new notes will take some time. In the meantime, cash payments could be handled by foreign currency notes (acquired from relevant central banks, likely the euro) or by using other stamped alternative currency notes. With the euro notes, there would be two alternatives. They could be stamped provided the ECB is willing to sell the requested selection of notes to the BoF. Under capital controls and with a 1:1 exchange rate between the euro and NM, it could also be possible to conduct the cash payments using existing euro notes. The actual conversion would happen only in the border with the foreign payments. There would be no need to hoard cash, and euro notes would hold their nominal value after NM cash was available.

Although Finland lacks a domestic system for bank clearing, she has two important advantages that reduce the implications of this for an exit. First, Finland has relatively few banks, and 90 % of all retail payments are handled by the three largest banks (Co-operative banking group OKO, Sweden-headquartered Nordea and Denmark-headquartered Danske Bank). Second, a vast majority (over 80 %) of retail payments are made using either cards or digital payment systems. Efforts could be made to temporarily make the share of internal bank payments even greater than at present.

One of the key issues in the exit process is ensuring that a national central bank may start working effectively as soon as the political decision on exit has been taken. The legal basis for the BoF after an exit would be the reintroduction of the main parts of the parliamentary Act of the Bank of Finland which was scrapped in 1998 [HE6/1998]. The new Act would place the BoF under the nominal supervision of the Parliament of Finland and reduce its membership status in the European System of Central Banks (ESCB) to the level of a member not using euros such as Sweden. Most importantly, the intermittent wish of Finnish authorities to rigidly fix the exchange rate to other currencies or currency indices should, in the case of exit, be carefully avoided.

Debt and solvency of Finlands institutions

The external funding position of Finland, is relatively good. At the end of 2016, Finland had a net foreign gain of around 15 billion euros. The Finnish banking system is presently low-risk, and the overall indebtedness level in Finland is still moderate.

Most of the loan stock and deposits of Finnish households and corporations is governed by Finnish law and can therefore be a candidate for instant redenomination to NM under lex monetae. Most of the debt is under Finnish law and can be redenominated to the new national currency. However, a significant portion (around 58 billion euros) is under, e.g., English or Swedish law.

According to the State Treasury, the Finnish government held a gross debt position of 110 billion as of Q4 2016. All of the debt is under Finnish law and consists of Finnish jurisdiction bonds. However, around 45.5 billion of these bonds carry so-called collective action clauses (CAC), which require creditor acceptance of any redenomination, which would probably have to be paid in their respective currencies.

Legal issues

There was no referendum on joining the euro in Finland, and so there is no need to have one for an exit Finland joined the euro through a government proposal, and there was no change in the constitution. This makes exit from the Eurozone technically easy, because It would require only a change in regular laws.

Fixit

Our report concludes that Finlands exit from the European common currency would be possible but a difficult task. The high and growing state of integration, especially in the area of payments and financial systems, has bound members of the euro area together strongly, as intended. Still, it is our finding that these ties can be severed without economically catastrophic results even in the short run.

Because we do not have any examples of a country exiting the euro and/or no exit clause specifying a detailed path out of the euro, estimation of the costs can be nothing more than sophisticated guess work. Assuming no problems with euro area institutions, the immediate direct costs of an exit could be in the range of 10 billion euros. This is mostly due to the very good external debt position Finland still poses.

Finns and other European citizens should acknowledge that the euro area will either develop into a federal union or break up in some way. In the long-run, there will be no middle-ground . If these profound alternatives are acknowledged, thorough preparation for the day when euro area management may prove impossible should be in the interest of every responsible decision maker in the member states.