funded in the currency of the loans given, but they failed to see the corresponding increased credit risk. other risks were less prominent in the swedish crisis but, in my opinion, will be of increasing importance to banks all over the world. among those are operational risks. several recent financial debacles, such as the baring crisis, were due to operational risk. even though the y2k problem was successfully managed, the huge computer systems of banks could cause large losses if technical or other failures occur. another risk, which in my mind will become increasingly important, may be called “ strategic risk ”. the financial market in most countries is highly competitive. in order to survive and prosper, banks must take bold decisions on new activities, new establishments, mergers, technological investments and so on. decisions like these have to be taken, but should they go wrong, banks may suffer large losses and may even go bankrupt. to handle these and other risks, internal controls and internal audit systems are becoming increasingly important. the huge mass of information in modern banking makes it impossible for supervisors to monitor individual transactions. they must rely on banks to maintain reliable internal control functions, which not only verify the accuracy of transactions and operations but also take a broader view of the bank ’ s compliance with its own rules and policies as well as with external rules and policies. supervision traditional supervision was of the type, which you may call “ checking the ledger ”, that is verifying that all transactions are properly recorded and formally correct. to some extent this must remain, but the supervisor ’ s efforts in this sense can be reduced by applying modern statistical methods, eg for sampling, and by making sure that banks have adequate internal control systems. instead, supervision should be risk - oriented and focus on those activities, which pose significant risks to the individual bank ( differing from bank to bank ). risk - oriented supervision also implies stricter supervision for large banks and for banks taking larger risks than others. supervisors should focus on evaluating and monitoring risk management systems, internal controls, corporate governance, and information systems. this calls for large supervisory resources and for more sophisticated skills : lawyers, but also economists, financial analysts, statisticians, mathematicians and accountants. if the law permits, which indeed it should, the supervisor could call on outside experts to assist. in order to be effective, supervision must in most cases be conducted on a consolidated basis, to include all parts of a financial conglomerate and even its non - financial affiliates. the increasing

##y risks larger and less transparent. nor were the financial supervisory authorities fully aware of the contagion risks in these new instruments. the complex financial instruments created in the search for yield when interest rates were very low did not comprise a problem as long as the situation on the financial markets was stable, but when the turbulence increased, it became very difficult to understand and evaluate these new instruments. it was the uncertainty over the value of the assets that led to many institutions facing problems when their assets declined in value at the same time as they suffered funding problems. some institutions were then forced to sell of some of their assets which further pushed down the value of the assets and led to new funding problems. there was a belief that the extensive trade in financial instruments meant that the risks were spread and that the system thus became more stable. in actual fact, the risks appear to have finally landed in the bank sector. the financial system was thus in practice more vulnerable than most people – including the financial supervisory authorities – believed. 3 expansionary monetary policy in the united states the expansionary monetary policy in the united states during the period 2002 – 2004 has also been held up as a possible contributory factor to the overheating in the us housing market and the ensuing financial turbulence. 4 some analysts feel that very low, short - term interest rates contributed to the overheating. however, it should be emphasised that inflation in the united states was low during this period and there were fears that the us economy would experience what is known as a liquidity trap, which could have had very serious consequences for developments in the real economy. here it was the experiences from japan during the 1990s and 2000s that caused alarm. following the financial crisis in japan at the beginning of the 1990s, prices fell and households postponed their consumption as they were expecting prices to continue to fall. the japanese central bank cut its policy rate to zero and let it remain there, but falling prices meant that monetary policy was nevertheless too tight, in real economic terms. the liquidity trap problem meant that growth was very low over a long period of time. for the three decades prior to the outbreak of the financial crisis in the early 1990s, the average gdp growth in japan was just over 6 per cent a year. following the financial crisis it has been just over 1 per cent a year. 5 because of the risk of a liquidity trap it was difficult for the us central bank, on the basis of the information available at the time, to do anything