november, when it last peaked. the depreciation seems to stem from several causes. it appears that net foreign currency inflows from trade in goods and services have been at a low ebb in recent months. while seasonal factors are at play here, it could also be that foreign currency subject to repatriation requirements is not being returned to iceland in full. this situation is being investigated by the bank ’ s capital controls surveillance unit. in addition, firms and municipalities have been paying down foreign debt. in many instances, they are forced to do so, as they have no access to refinancing from abroad and would otherwise default on these loans. but there are also signs that interest rates in iceland are low enough relative to corporate inflation and exchange rate expectations that some firms consider it in their best interests to convert foreign loans to domestic currency, which could be positive in the long run but puts pressure on the krona at present. this is one example of how the domestic interest rate level can affect the exchange rate in spite of the capital controls. finally, recent exemptions from the capital controls, which the bank has granted in cases where the exemptions were important for the growth and performance of the firms concerned and benefit the icelandic economy in the long term, have affected the foreign exchange market in recent weeks. in some instances, these exemptions have triggered short - term outflows, even though they may generate increased foreign exchange revenues in the future. this is why the central bank intervened in the foreign exchange market earlier this month. judging from recent public discussion, it appears to be a commonly held misconception that a currency depreciation within a capital controls regime is in itself a sign of a major problem. the krona can – and should – fluctuate within the capital controls, even if they work perfectly. trade in goods and services is unrestricted, firms and institutions are free to service their foreign debt, and all capital and the resulting outflows are unhindered. and all of these variables can fluctuate. the main aim of the capital controls is to stop uncontrolled currency outflows related to capital account transactions. but the controls affect the exchange rate of the krona and should do so. by all available measures and in international comparison, the krona has fluctuated less since the controls were imposed than it did over a long period prior to the banking and currency crisis. i have discussed recent economic developments and conditions, but what

reliable estimates of the size and portfolio composition of major counterparties were lacking and that improved credit risk management techniques were needed in two key areas : credit and market exposure measurement, and counterparty due diligence. let me be a bit more specific about some of the weaknesses found in credit risk management techniques. for example, some institutions routinely performed credit assessments using sparse, often unaudited financial information from valued customers, some of which had recorded substantial profits in previous years. moreover, institutions that received intermittent financial statements and had infrequent contacts with these counterparties were left to make periodic credit assessments using stale information in a rapidly changing market. this insufficient information impeded the setting of prudent credit limits and terms, including collateral requirements and contract covenants. many risk managers also failed to account fully for the risks involved in new financial products. non - traditional products, such as equity repos and credit derivatives, challenged existing credit – 2 – analysis systems and methodologies. in addition, relatively few financial institutions attempted to stress test credit exposures and even fewer anticipated a market environment as adverse as what we experienced in the third quarter. for these and most other institutions, the rush to mitigate and reduce their exposures, particularly to highly leveraged institutions such as hedge funds, quickly resulted in the widespread withdrawal of all lending activity to some troubled sectors, regardless of an individual counterparty ’ s financial condition. while these decisions undoubtedly were intended to reduce risk and avert losses, they also served to exacerbate already extraordinary financial market fragility. given that the task of assessing and managing risk is not going to get any easier as we move into the 21st century, let me now turn to some of the issues that i believe will challenge financial institution managers in the coming year and beyond. one issue is the increasing integration of banking, securities and insurance services ; a second is the increasing pace at which capital moves across international borders ; a third, the year 2000 problem ; and a fourth, the challenge of bringing improved risk management techniques to business operations as a whole, including the trading rooms. this is particularly important for participants in the rapidly changing fixedincome markets. first, the integration of previously separate financial services means that institutions must be prepared to manage risks across a far wider range of products, business units, and counterparties than they have been accustomed to doing. in the securities lending markets, for example, an increasing number of firms are accepting equities as collateral for financing