lars nyberg : issues in supervision of banks - the european experience speech by mr lars nyberg, deputy governor of the sveriges riksbank, at the association of professional bankers, colombo, sri lanka, on 26 august 2000. * * * background first of all, i want to thank you for giving me this opportunity to discuss with you some questions concerning the supervision of banks. the issue, i understand, is quite timely, since sri lanka has embarked on an ambitious project of developing the financial sector, opening the banking system to international influence and modernising it accordingly. a sound and well functioning financial sector is a key to economic development. this statement may sound uncontroversial in your ears, but it is not always accepted by the general public and by the politicians. the contributions of the financial sector are sometimes hard to explain in simple terms and people tend to look at banks with suspicion. to create credibility and respect for the financial sector in general and most importantly for banks, a proper and well - developed supervision is essential. bank of sri lanka has realised this and initiated a comprehensive upgrading of bank supervision. in my view this is exactly the right point to start developing the financial sector. supervision, however, is developing quickly. supervising a traditional highly regulated banking system is far different from supervising a deregulated system open to foreign competition. furthermore, going from a state of strict regulations to one of deregulation implies risks for undermining banking stability. many countries, not least my own, have had bitter and expensive experiences from this. of course, all countries have specific national features in their banking systems. the main risks are common all over the world, however, and the same challenges to supervision seem to appear everywhere. i will focus on some important issues seen from my perspective, which includes the experiences we gained during the swedish banking crisis in the early nineties. deregulation why deregulate if the consequences may be so dangerous? the obvious answer is that regulations tend to create inefficiency and prevent the domestic banking system from developing in response to international competition. the long run cost to society of extensive regulations is a poorly functioning financial sector. while regulations are usually put in place to decrease systemic risk they may indeed in the long run do quite the opposite. strong regulations mean that banks have low incentives to adopt good credit policies and risk management techniques. supervision tends to be excessively formal, focusing on formalities rather than on actual risks. nor are the regulations and

strength in business investment and exports, in conjunction with a global economic expansion that is becoming more synchronous ( chart 6 ). imports are also expanding ; the increases we are seeing in imports of machinery and equipment and of various intermediate products are early signals of rising business investment. it was in this context that the bank of canada decided, in july and again earlier this month, to raise our 7 / 10 bis central bankers'speeches policy rate. we will be paying close attention to how the economy responds to both higher interest rates and the stronger canadian dollar. looking ahead, canada ’ s openness to international trade is an important determinant of canada ’ s economic growth potential — that is, of how fast the canadian economy can grow without giving rise to inflationary pressures. that growth potential could be greater than we think — if businesses find new ways to engage with gvcs and develop new products and processes to make them more productive and competitive. as in the past, further expanding canadian firms ’ access to markets and to imported inputs could unlock more opportunities. an example is the canada – european union comprehensive economic and trade agreement, most of which will be implemented in the next few days. but some other developments are more concerning. with the rise in protectionist sentiment in some parts of the world, we have been entering a time of heightened uncertainty about the rules of the game on international trade. the possibility of a material protectionist shift — particularly regarding the outcome of negotiations on possible changes to nafta — is a key source of uncertainty for canada ’ s economic outlook. given the nature of international trade in the 21st century, the stakes are very high. as i discussed, the economic benefits we have experienced from trade liberalization were not only in expanding the markets for canadian exports. we also benefit from the greater efficiencies that can be achieved by those exporters that do expand, the heightened competition and better access to imported inputs that come with greater openness to imports, and the resulting spur to innovation throughout the gvcs. if trading rules are changed in a way that undermines these benefits, the result would be both lost external demand for exports and lower potential growth for canada as well as for the united states and other trading partners. 8 / 10 bis central bankers'speeches conclusion as an open economy, canada ’ s fortunes will continue to rise or fall with trade, as they have throughout our history. global economic forces — the sharp movement of commodity prices ; the great recession