Participants are the commercial banks, savings banks and Central Bank. The Icelandic Banks’ Data Centre provides software services for both systems and the Central Bank acts as a settlement provider. These systems are described in detail in the Central Bank’s annual report. Since 2001, the Central Bank has been working in close collaboration with Fjölgreiðslumiðlun, the Icelandic Banks’ Data Centre and credit institutions on development of payment systems with the aim of bringing them into compliance with the BIS Ten Core Principles for Systemically Important Payment Systems. This work has focused on clarifying the qualifications and responsibility of management and netting system participants. Settlement processes have been reviewed with respect to finality of payments and timing of settlements. Risk management has been strengthened by defining and monitoring risks, making debt positions visible, restricting debt positions and requiring collateral for settlements. Arrangements for oversight, communication of information and contingency plans have also been reviewed. An important landmark in the development of these systems was reached last year when two sets of rules were adopted, on the Central Bank of Iceland’s real-time gross settlement system and on activities of netting systems. At the end of the year the systems were designated and notified to the EFTA Surveillance Authority. The real-time gross settlement system and netting system have thereby been recognised as legitimate payment systems in Iceland and across the European Economic Area. Also in 2003, the Central Bank and FME [Financial Supervisory Authority] signed a cooperation agreement on oversight and prudential supervision of payment and settlement systems.

The main shock to financial stability and monetary policy would be if asset prices were to drop sharply at the same time as the growth of real disposable income slows down at the end of the aluminium-related investment boom. Lending developments As I mentioned before, lending growth is a cause for concern, both for financial stability and the Central Bank’s inflation target. Domestic lending grew at a brisk pace in 2003 and this development appears to be heading in the same direction this year. Total domestic lending by deposit money banks over the twelve months to the end of January increased by about 23%, which is above a rate consistent with longterm price stability and economic stability. The period 1998 to 2001 provides a recent example of the consequences of heavy credit growth. Both arrears and loan losses rose in the wake of the credit boom, leading to a temporary tightening of the commercial banks’ and savings banks’ foreign funding. While the recession and the ensuing strain on the financial system are now over, it can be partly ascribed to relatively favourable economic conditions and the consequently sharp turnaround in the exchange rate of the króna that financial companies only sustained minor setbacks. Proportionally, the highest growth in deposit money banks’ lending has been to foreign borrowers, but foreign currency-denominated lending to domestic entities has also surged, by more than 45% over the past 12 months.