aims at limiting system - wide distress and avoiding output costs. an important concept here is systemic risk ; the risk that liquidity or solvency problems in a bank may cause liquidity problems or insolvency in other institutions. thus, correlation and common exposures across institutions are important in the macroprudential approach. the second approach deals with risks originating from outside the financial system. this field has increasingly been recognized by researchers and policymakers in later years. strong growth in debt and asset prices, as well as macroeconomic disturbances like a surge in commodity prices or the unwinding of large imbalances in the world economy, can ultimately affect financial stability in a negative way. to identify potential sources of instability, we need indicators that contain useful information. with an estimate of the equilibrium values of debt ratios or asset prices, for example, we can study the gap between their current value and their equilibrium value. 4 if the gap is wide, the danger of a significant consolidation is present. however, the results must be interpreted carefully. equilibrium values are inherently difficult to determine, and it is not obvious that there is a stable and significant relationship between gaps and future economic activity. in addition, decisive factors in the judgement of the financial situation, like agents ’ confidence in the financial system, are also difficult to incorporate in the analysis. a related approach is to analyse the potential impact of adverse macroeconomic shocks on financial stability. stresstests are commonly used for this purpose. such tests investigate banks ’ ability to withstand different types of shocks under various economic conditions and with different monetary policy responses. when conducting stresstests, macroeconomic models have proven to be valuable. however, considerable work remains to be done in order to capture the behaviour of economic agents in the case of extreme macroeconomic events. hoggarth, glenn, ricardo reis and victoria saporta ( 2001 ). “ cost of banking system instability : some empirical evidence ” bank of england financial stability review, issue 10, article 5, june see for example borio, claudio ( 2003 ). “ towards a macroprudential framework for financial supervision and regulation? ” bis working paper no. 128 see for example borio, claudio and philip lowe ( 2004 ). “ whither monetary and financial stability? the implications of evolving policy regimes ” bis working paper no. 147 financial markets and institutions have become more interdependent. the possibility of contagion across borders thereby increases. cross - border capital flows

- long consequences for economic developments. all that said, however, the challenges facing banks today require a broader set of instruments than those used by the nordic authorities 20 years ago, for two main reasons : first, the situation for banks is more complex. the authorities have to distinguish more clearly between insolvent banks and banks that are solvent but in need of more capital in order to increase lending. the lessons from the nordic banking crisis can be drawn on for the insolvent banks. for the solvent banks, the challenge is to maintain their lending capacity. this is particularly important given that other credit markets are not functioning normally, so that it is difficult, or impossible, for businesses to acquire funding directly from bond markets. but without more capital, the banks are not willing to accept new loans on their balance sheets. the main challenge facing the authorities today therefore is to ensure that solvent banks increase their financial strength and thereby their lending capacity. at the same time, it is important to have an exit strategy so that capital injections today do not translate into an increase in state ownership when the crisis is over. second, cross - border banking has been increasing. twenty years ago, all the main nordic banks were national banks. today, for example, four of the five largest banks in norway are foreign - owned ( three branches and one subsidiary ). a national authority cannot be expected to bolster the financial strength of branches of foreign banks : indeed, it could be complicated to do this even for foreign - owned subsidiaries. while we were able to choose national solutions to the banking crisis 20 years ago, any effective solution to today ’ s situation will require an internationally harmonised approach. as today ’ s financial crisis progressively gets resolved, it will be necessary to start the process of preventing future crises. this will require substantial reform of the regulatory framework. banks will have to strengthen their capital and their liquidity buffers. and financial regulation must have a less pro - cyclical effect. the objective must be to enable the banks to curb the impact of shocks on the economy, rather than to amplify them, as is the case now, where negative spirals are generated between the financial system and the real economy. because of the global character of today ’ s financial crisis, the authorities must work in concert to find solutions, both in terms of recapitalisation of the banks and regulation of the financial sector.