the volatility of capital flows. however, in spite of widespread unease about the current state of affairs, such reforms do not seem likely anytime soon. furthermore, there are complex unsolved issues involved regarding potential conflicts between domestic and global objectives. that leaves us with what individual countries can do. in principle, they have three avenues to mitigate the problem. the first is to adjust macroeconomic policy frameworks. the second is to use prudential regulation and supervision aimed at reducing vulnerabilities and increasing resilience in face of volatile capital flows. the third is to introduce tools aimed directly at the financial integration part in order to regain greater monetary independence and shift the effect of monetary policy more to the interest rate channel and towards the non - traded goods sector. this could, for instance, be some form of a variable tax or reserve requirement that would make the relevant capital inflows more expensive and thus limit the increase in the effective interest rate differential vis - a - vis abroad when domestic interest rates are raised. there are complex design, governance, and international issues involved that i do not have time to expand on here. what should be stressed, however, is that it is not optimal that countries are increasingly forced to take unilateral action in this domain. credible and reliable co - insurance is better than self - insurance. at least, the imf should monitor the process, and further ahead, some rules of the game regarding capital flows would be welcome so that we are not faced with excessively sub - optimal outcomes and unintended consequences for the global system. see for instance mar guðmundsson and thorsteinn thorgeirsson, “ the fault lines in cross - border banking : lessons from the icelandic case ” suerf studies 05 / 2010, european money and finance forum ( 2010 ) ; mar guðmundsson, keynote address at the eighth high - level meeting for the middle east & north africa region : recent policy developments for strengthening the resilience of the financial sector, abu dhabi, 28 november 2012. www. cb. is ; and mar guðmundsson ‘ s speech at the iiea conference in dublin, ireland, “ iceland ‘ s crisis and recovery : facts, comparisons, and the lessons learned ”, 27 april 2015. www. cb. is. bis central bankers ’ speeches let me conclude by telling you what we are contemplating in iceland in this regard, as this issue is very much on the agenda as we prepare

which clearly facilitated the cross - and off - border expansion of the icelandic banks through the so - called european passport. it was and is deeply flawed. the basic problem is that the freedoms are not matched by public action and frameworks at the eu and eea level. bank size relative to country size was assumed to be a matter of no concern, and fx risk was largely ignored. based on the icelandic experience, a banking union makes perfect sense, but only fully for the eurozone, and even then it has to include all three elements – common supervision, resolution, and deposit insurance – in order to break the deadly embrace of banks and sovereigns. in the interim, i think small countries, especially those with their own currencies, will have to impose their own prudential measures in order to defend themselves against the risks they face. the third lesson relates to the structure of the financial sector in small, open economies in the absence of robust and credible international or regional safety nets. to my mind, international financial centres cannot be located in such countries without some ex ante mechanism that at least partly insulates the domestic economy from the risks involved. in some sense, this is what iceland did in the nick of time in early october 2008. furthermore, in very small, open economies with their own currency, like iceland, the international activities of domestic banks and fx risks on their balance sheets must be limited and regulated. in this context, we have been thinking about the prudential regime that must be in place in iceland when we have lifted capital controls and icelandic banks are again free to use their european passporting rights. we will have more stringent restrictions on permissible currency mismatches than in the past, also taking into account positions of unhedged households and companies, but more importantly, we will, through some combination of lcr - and nsfr - type ratios in foreign exchange, put strict limits on fx maturity mismatches. the combination of these and other measures will make it impossible for the banking system to attain the size and cross - border reach it had before the crisis. the big question is whether it will be deemed compatible with the eea agreement. bis central bankers ’ speeches more generally, i think the distinction between macroprudential measures and capital controls can be more complex than many make it out to be. the fourth lesson is on capital flows : deal with the inflows if you want to avoid the risk of having to introduce comprehensive capital controls