The bank of the Faroe Islands can help guide Scotland

IN trying to understand the role of money in the economy, it is always important to question assumptions about what must be true. The Scottish Currency Group started because the SNP leadership decided that it would be impossible to establish a separate Scottish currency in the first few years after independence.

For the past five years, whenever anyone in the independence movement has popped up claiming that it would be very difficult for Scotland to set up its currency quickly, the Currency Group has been there to help them check their assumptions. Commitments to set up the new currency “as soon as practicable” have gradually leached from SNP conference resolutions into Scottish Government position papers, and now into the thinking of Believe in Scotland.

Much as members of the Currency Group welcome these commitments, its job is still not complete. It is now time to challenge the assumption that it is impossible to start the preparations for issuing the Scottish currency until after Scotland has decided to become independent.

Only a little over 200 miles north-west of Shetland lie the Faroe Islands. The islands’ population is about 54,000. Since 1948, they have been a self-governing community within the Kingdom of Denmark. The islands’ autonomous status extends to the Faroes not being in the EU whereas Denmark is a member.

The capital of the Faroe Islands Tórshavn

While the Danish Krone is the local currency and the Faroese government receives an annual grant from Denmark, the islands have considerable economic autonomy. Moreover, should the Faroes ever decide that they want to sever ties with Denmark, they have institutions in place which could easily be turned into a central bank.

The most important of these is the Landsbankin. Wholly owned by the Faroese government, but jealous of its operational independence, this was established as the islands’ debt management office and public treasury. It manages its asset portfolio so that the government always has access to sufficient cash to make payments.

One of the reasons given for supposing that it would be very difficult to set up a Scottish currency is that it would take years for the Scottish Government to build the reputation for probity needed to issue its own debt. Yet the Landsbankin can issue bonds in both Reykjavik and Copenhagen, which are treated as sovereign debt. The interest rate on the debt is only about 0.5% per year higher than the Danish government pays.

Admittedly, the Faroes government is in the happy position of having been able to run modest budget surpluses for many years. With that conservative fiscal stance, the total debt which the Landsbankin manages is worth about £460 million, or £8500 per head. And it is balanced by liquid reserves of about £425m.

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With a staff of 10, it might seem that we are talking about little more than the treasury function of a local authority. However, the Landsbankin has added systemic regulation to its portfolio of responsibilities.

That reflects how the practice of financial regulation has changed since the financial crisis. It’s an area in which the Bank of England has invested quite a bit of effort – thinking about how to ensure that the country’s financial system will be resilient, rather than trying to ensure that individual institutions are sound.

With the prudential regulation of Faroese banks remaining part of the responsibility of Denmark’s Nationalbank, there might not seem to be much need for the systemic regulation of the four local banks in a tiny economy. But the Faroese just need to look to their neighbours in Iceland to realise what can go wrong when bankers become buccaneers and bulk up their institutional balance sheets with foreign debt.

For the Landsbankin team, since Denmark is so far away, it is important for someone local to be there to oversee the banking activities.

As well as all that, the Landsbankin also manages the labour market pension fund. With an ageing population, and expecting that the economic environment of the islands will become more challenging, the Landsbankin has started to warn politicians on the islands that it is already becoming more difficult to run the local economy.

The Faroese have been able to develop these economic management arrangements while the islands are still part of Denmark. Their access to capital markets has made it possible to raise the funding needed to build inter-island tunnels – including the world’s first sub-sea roundabout. And all this has been done by a community whose population is only a little larger than Kirkcaldy’s.

We can point to the Faroes as showing the extent to which it would be possible for Scotland to develop institutions which, after people choose independence, could easily be adapted and extended to take over the full economic and financial responsibilities of an independent State.