A stable financial system features solid cushions that reduce the risk of problems spreading from one institution or market to other institutions or markets, or across borders. This risk constitutes a systemic risk, i.e. the risk of failure of the financial system. 1  BIS Review 124/1999  Disturbances that may develop into a systemic risk can be transmitted through financial institutions and financial markets. Stable institutions are solid institutions in which there is general confidence, whereas stable markets are markets where there are no “excessive” price variations. The banks are in a special position. They transform short-term deposits into long-term loans. They are responsible for payment settlements, and bank deposits serve as a means of payment. The volume of amounts outstanding in the interbank market is sizeable. As a result, problems in one bank may rapidly spread to other banks. The financial strength of banks is thus important for financial stability. The more capital a bank has the larger the losses it can absorb. The risk of contagion is thus reduced. A bank’s capital adequacy ratio is not the only variable that must be taken into account. A bank’s earnings provide an indication of the bank’s future financial position. Another important factor is the size of a bank’s loss provisions. Financial unrest spreads through payment and settlement systems. These systems can also be at the origin of risk. This occurs when banks credit customers before they have received settlement from the payer bank.

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.