In the panic that gripped global financial markets after the collapse of Lehman Brothers, these banks were faced with a wholesale run on their foreign currency liabilities and were therefore heading towards a default on those liabilities in the absence of LOLR assistance in foreign currency. However, given the size of the banks, it was impossible for the Icelandic authorities to provide such assistance on their own. There was actually a plan to nationalise one of the banks in late September 2008. Fortunately it failed, as nationalising the bank would have turned a private bank’s foreign currency refinancing problem into a sovereign problem, with the serious risk that the sovereign might have defaulted on such foreign currency payments, thus initiating a full-scale sovereign debt crisis. Figure 2 gives a sense of the potential scale involved in the case of the three banks, by comparing the foreign currency liabilities of the banks and the Central Bank’s FX liquidity at the time. Figure 2  2  BIS central bankers’ speeches  Based on published financial accounts and the analysis of the supervisor, the Icelandic authorities assumed that the banks were solvent. On that premise, the authorities tried to build defences against potential foreign currency liquidity problems at the banks by negotiating swap lines and tapping foreign capital markets, in both cases with limited success. Now, however, we know that there were hidden vulnerabilities in the banks’ capital positions. However, given the lack of international cooperation, the Icelandic authorities were forced to consider radical solutions.

Risks: Going forward, we expect economic growth to moderate, while remaining robust and well above the euro area average. We consider that risks around this scenario are balanced. On the upside, there is the potential for private consumption to grow even more rapidly in a low interest rate environment especially if labour productivity increases to permit higher wage settlements. The downside risks relate mostly to the external situation. Malta is one of the most open economies in Europe, heavily dependent on international trade for its long-term prosperity. Slower than expected growth in key trading partners, geopolitical tensions in our immediate neighbourhood and a resurgence of protectionism threaten this prosperity. Another dimension of risk relates to inflation. I have already explained that the Bank  believes that Malta’s potential economic growth rate has risen in recent years, implying that the economy can grow more rapidly than it used to without fuelling inflation. Nevertheless, output currently exceeds potential. Page 5 of 8  Should such a situation persist, we would normally expect to see upward pressures on prices and costs. We have not observed them yet, as wage growth has remained largely contained and foreign inflation is subdued. The labour market situation, however, is tightening, which could lead to an intensification of wage pressures. This underlines the need to achieve better results in labour productivity growth to support wage demands without loss of competitiveness. In addition, global oil prices are now rising after having reached a trough towards the beginning of this year.