the bank ’ s two most important tasks at present, and in fact at all times. the first concerns the inflation target and figures connected with it. the second is the position and performance of financial companies. as it happens these two issues are generally interlinked, because decisions by financial companies have a strong impact on the first task, and imbalances in the icelandic economy can affect international analysts ’ assessments of the position of the financial sector. but be that as it may. i was interested to note that my cautious predecessor as chairman of the board of governors described in his last address to the annual meeting how the strong growth in lending by the banks showed that they have overstepped the mark. those were the words he used. he was discussing the impact on growth, overheating and inflationary pressures in the economy. i quote : “ the surge in lending over the past two years is a cause of concern both for financial stability and the central bank ’ s inflation target … lending by the credit system as a whole increased by 16 % in real terms last year. ” unfortunately these cautionary words had no effect, because on top of the 16 % increase in lending in real terms in 2004 came a further 25 % increase in lending in real terms in 2005. this must be changed. the board of governors of the central bank has held productive meetings with leaders of the banking sector to discuss this question among others. statements have been issued in these meetings boding a more cautious approach in the future. the board of governors has no reason to doubt the integrity behind these promises. however, lending has continued to grow in the first months of this year, and at a faster pace than in 2004. the difference in practice is explained by the time it takes to clear promised loans which are in the pipeline. the central bank still has faith that these planned improvements will materialise, since a great deal is at stake. in his address last year that i quoted from, the former chairman of the board of governors also said that changes in their activities and strategies have left the banks more exposed to shocks originating in foreign markets. recently we have seen instances of this. admittedly, a lot of what was said in the much - quoted reports by international analysts is misrepresented, and some of it based on misunderstandings, wrong information and, occasionally, obvious antipathy towards the icelandic banks and their activities. this is all regrettable and, in some cases, deserves to be condemned. but these cases

1998 when that function was merged with the insurance supervisory authority in a new and unified financial supervisory authority, with which the central bank cooperates quite closely on financial stability issues. while the central bank had responsibility for banking supervision, its attention was necessarily focused on individual institutions and overseeing that their operations complied with existing laws and regulations. before banking supervision was transferred elsewhere, the central bank had also begun to focus its attention on broader financial stability issues along the lines that many other central banks were doing at that time. a logical part of that process was that in 2000 the bank began to publish semi - annual financial stability analyses in its quarterly monetary bulletin. one reason for the increasing focus of the bank on systemic financial stability issues in the late 1990 ’ s was the growing perception in a liberalised financial market that a weak financial system could undermine economic and monetary stability just as much as economic imbalances and weak policies could undermine an otherwise sound financial system. a sound financial system, including safe and secure payment and settlements systems, is also an important precondition for the effective implementation of monetary policy. capital movements were fully liberalised in the 1990 ’ s, as was the domestic financial market which also underwent significant structural change, including the withdrawal of the government from direct ownership in banking institutions. these developments stiffened competition at home and linked the domestic financial system much more closely to international markets. consequently, in its analyses, the central bank consistently draws attention to the potential vulnerability of the domestic financial system to changes in the external environment, including the ready availability of foreign credit for refinancing purposes, and its vulnerability to sudden changes in the exchange rate. the developments in the icelandic economy towards the end of last decade and into this one resembled in many ways those experienced in some of the other nordic countries a decade earlier. needless to say, and in view of the experience of other nordic countries, these developments caused considerable concern about the underlying stability of the financial system. the central bank candidly expressed these concerns in its financial stability reports, most notably in the spring of 2001. at that time the imf also issued its financial stability assessment which questioned the strength of the financial system in iceland in view of the tremendous imbalances in the economy and what was perceived to be an underlying weakness in the banking institutions. the imf identified a potential risk of a rapid depreciation of the currency, which it felt could further weaken the banks and pose a threat to them. early on in the upswing, amidst a rapid