by central bank and authorised it to borrow abroad in the name of the treasury in order to strengthen its foreign reserve substantially, while the government was also mandated by parliament to strengthen the bank ’ s capital position. the board of governors would like to thank the government for such a good, firm response. the foreign loan that the central bank was authorised to take was its largest on behalf of the treasury so far. it can only be said that this was a highly successful measure – in fact, a respected international financial journal ranked it one of the ten most successful international bond issues worldwide last year. the borrowing terms were very favourable and of course reflected the confidence enjoyed by the republic of iceland in the market. the central bank ’ s greatly enhanced capital position and stronger foreign reserves do not signal any shift in its policy, but represent a natural response to changes in the environment in which the bank operates. at last year ’ s annual meeting we all had serious concerns about the peculiar discussion and sometimes unfounded speculation aired then about the icelandic banks, their position and strength. there is no doubt that this debate and the ensuing events made conditions tighter for the banks for a while. the banks responded firmly to the uncomfortable position that had arisen. they made great efforts to explain the structure and organisation of the icelandic banks. this was no half - hearted measure, but a steadfast and confident approach which produced results. the banks adjusted certain aspects of their operations and operating environment in response to relevant criticisms, and dismissed what was less relevant with explanations, reports and candid communication, at large meetings, small meetings and man - to - man, depending upon which was most productive. they needed temporarily to look beyond their traditional markets for funding, and unquestionably these conditions put their resources and management under strain. it can definitely be said that those involved passed this difficult test. the funding problem that loomed around this time a year ago is a thing of the past, terms in the secondary market have been normalised and market confidence has been restored. this is to be welcomed. what remains, however, is of course that people are now more aware of the widespread risks that the future may hold in store. global market conditions can change suddenly. credit access, which in recent times has been exceptionally favourable for icelandic and other banks, may change suddenly if unexpected conditions arise. it is important to be prepared for such a contingency. at the height of this furore, i would venture to say that the central bank made

of their deposit base has survived as an independent entity. banks have changed. they have encouraged the expansion of proprietary trading, the funding of long - term assets in short - term wholesale markets, a rapid expansion of balance sheets and a marked rise in leverage. commercial banks followed the path of investment banks. balance sheet size and high leverage were seen as the key to obtaining funds at lowest cost. the total assets held by the world ’ s largest banks roughly doubled in the five years to the end of 2008, and leverage in uk banks rose on average by two - thirds. the bulk of credit growth in the economy as a whole was taking place within the financial sector. and the complexity of the products being created made it hard to evaluate the underlying risks. why did banks change so much and take risks which eventually led to some spectacular downfalls? ultimately, the main factor was an inability to perceive the true nature of the risks involved. in this they were not alone. john maynard keynes took pains to distinguish between risk, where probabilities or frequencies could be calculated, and uncertainty, where there is no scientific basis on which to form any probability estimates. keynes went on, in an article published in 1937, to spell out exactly how we tend to behave in the face of such ignorance. it explains a great deal of recent behaviour in financial markets. keynes argued that uncertainty affects our behaviour in three ways : “ ( 1 ) we assume that the present is a much more serviceable guide to the future than a candid examination of past experience would show it to have been hitherto. in other words we largely ignore the prospect of future changes about the actual character of which we know nothing. ( 2 ) we assume that the existing state of opinion as expressed in prices and the character of existing output is based on a correct summing up of future prospects, so that we can accept it as such unless and until something new and relevant comes into the picture. ( 3 ) knowing that our own individual judgement is worthless, we endeavour to fall back on the judgement of the rest of the world which is perhaps better informed. that is, we endeavour to conform to the behaviour of the majority or the average. the psychology of a society of individuals each of whom is endeavouring to copy the others leads to what we may strictly term a conventional judgement ”. this suggests that it is very hard to take a truly independent view – especially a contrarian one that recognises the possibility that improbable but con