this type of asset, the crisis nevertheless affected them. like the swedish economy as a whole, the swedish financial system is very dependent on other countries. for example, only half of the banks ’ funding is deposits from private individuals, companies and institutions in sweden. the rest is borrowed on the market, and a large part of this on international markets. moreover, most of the funding is relatively short term. this is not unique to sweden. the advantage is that it reduces the banks ’ funding costs, which in turn makes it cheaper for households and companies to borrow money. but there are also disadvantages. as the banks have made themselves more dependent on the outside world, they have of course become more vulnerable to problems arising abroad. when the international money markets slammed on the brakes in autumn 2008 the swedish banks ’ funding was immediately affected. not least because they had borrowed money in the short term. so unlike the crisis of the 1990s the crisis we have just experienced is largely an imported one. but the swedish banks had also become involved in activities that proved to be risky. i refer to their lending in the baltic countries. these exposures also affected confidence in swedish banks during the crisis. as we are affected very directly by disruptions on the international financial markets, it is in our interests to have functioning global regulation. we therefore welcome the proposals made by the basel committee. hopefully, the new regulations will contribute to preventing new crises in the financial system, or will at least alleviate their dramatic effects. more capital of better quality provides larger buffers i shall begin by describing the new requirements regarding the banks ’ capital. because this is what a large part of the changes agreed by the basel committee concern. one can say that this capital is the money at the bottom of the treasure chest that the financial supervisory authorities require the banks to always hold. the banks have long been obliged to observe special minimum levels regarding the size of their capital. there are two main reasons for this. the first is that the capital is to reduce the costs to the state if the bank fails. even though sweden escaped relatively lightly on this occasion, we know from experience that such costs can be very extensive. for instance, the state may be forced to take over bad assets or have to pay money to depositors under the swedish deposit guarantee scheme. but the role of capital is primarily to reduce the risk of a bank failing at all. when the bank suffers losses it should have a capital buffer to meet them and thereby be able to continue

, the expansion of the capital stock may go too far. sizeable investments are made in sectors that will never yield the expected return. the subsequent adjustment accordingly involves a marked fall - off in investment activity and thus a weak development of demand. both the excessive investment earlier and the inevitable correction of asset prices contribute to this. the setback can also lead to problems in the financial system in general. much of what the austrian school had done was forgotten during the half - century of regulation from the crisis in the 1930s to the 1970s. political economy was dominated instead by keynesianism. it may also be the case that the efficient market hypothesis has been interpreted too freely. this theory largely amounts to a warning that the market is basically the best judge of a share ’ s real value. under normal conditions that is probably true. when a bubble has got under way, however, the market ’ s normal information processing tends to be disrupted and prices are driven instead by impenetrable forces of a psychological nature. in many respects the financial turbulence in the 1980s and ‘ 90s was a rude awakening for many economists, decision makers in economic policy, authorities, representatives of the business and banking communities and people in general. i find it important to underscore how broad was this lack of insight into how financial problems arise. one cannot single out a person or group as being solely responsible for how things took a turn for the worse. perhaps a society has to undergo a learning process on a broad front so that earlier mistakes yield new insights. economic policy decision - makers like myself are, of course, no exception here. but as financial turbulence does not inevitably lead to a serious crisis in the real economy, we need to ask why it is that in certain cases output and employment do suffer severe setbacks and the attendant deflation. much will have been gained if we can learn to tell whether or not an extensive share price fall, for example, besides being troublesome enough for many people, is likely to result in a situation with general deflation, rapidly falling output and rising unemployment. an answer to that question was suggested in the summer of 1999 by the federal reserve chairman, alan greenspan : while bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy. the bursting of the japanese bubble a decade ago did not lead immediately to sharp contractions in output or a significant rise in unemployment. arguably, it was the subsequent failure to address the damage to the financial system in a timely manner that