A bank may thus seek to increase the expected return by taking on higher risk without having to pay for this in the form of higher borrowing costs. Market discipline is weakened when operators are sheltered from taking the full consequences of their own actions. This is referred to as moral hazard. The authorities must regularly undertake a critical review of regulations to determine whether they are formulated with a view to achieving the overriding objectives at minimum cost. 3. Work on crisis prevention since the banking crisis  The lessons drawn from earlier banking crises are the primary means of preventing new crises. The debt crisis in the 1920s was at the root of the caution that continued to be exercised many years later. Operators are still cautious as a result of the banking crisis in the 1990s. The memory of earlier experiences fades over time. It is imperative to establish framework conditions that deter borrowers and lenders from taking excessive risk. The central framework conditions include effective legislation and regulations, a robust payment and settlement system, and effective supervision of institutions and markets. The capital adequacy regulations are more stringent today than when the banking crisis erupted. Sound capital adequacy strengthens banks’ capacity to bear unanticipated losses. The size of the banks’ capital base also sets limits for lending growth. The capital adequacy requirements are being revised. This will also have implications for Norway. The new Bank Guarantee Act is another important change to regulations. The Act provides for a deposit guarantee.

Before the settlement is finalised, Norges Bank verifies whether the banks have sufficient funds in their accounts in Norges Bank. The introduction of collateral requirements for banks’ loans has lowered the risk assumed by Norges Bank. Supervision has been substantially strengthened since the banking crisis. The Banking, Insurance and Securities Commission’s resources have been increased. Greater emphasis is placed on on-site supervision. The methodology for document-based supervision has been improved. Internal control routines have been enhanced. International surveillance cooperation has also been strengthened. In addition, the authorities have become more aware of the importance of monitoring the financial system. The aim is to identify emerging tensions and possible sources of system failure at an early stage. 4. Prevention work in Norges Bank  The work undertaken by Norges Bank to maintain financial stability can be divided into three areas of activity: •  continuous monitoring of factors that affect financial stability;  •  work to reduce the risk in payment systems and increase their robustness; and  •  assess the effects of monetary policy and economic policy in general. Surveillance Surveillance primarily consists of analyses of the relationship between macroeconomic developments and the financial strength of financial institutions. Norges Bank’s analyses are presented in semi-annual reports on financial stability, called “Financial Sector Outlook”. Experience shows that effective surveillance requires more than monitoring the earnings and capital adequacy of banks and other financial institutions. Developments in other markets must also be monitored.