mar guðmundsson : capital flows and systemic risk in iceland panel comments by mr mar guðmundsson, governor of the central bank of iceland, in norges bank's ( central bank of norway ) 200th anniversary symposium, oslo, 16 june 2016. * * * in my short introductory remarks, i would like to discuss what i consider to be one of the key factors behind the financial crisis in iceland : the interaction between capital flows and systemic risk. i will focus in particular on those aspects that have more general relevance and herald unsolved problems for economic management and financial stability in small, open, and financially integrated economies ( sofies ), such as iceland was before the crisis and now strives to be again, at least up to a degree. the saga of iceland ’ s experience during the great financial crisis had two separate but interrelated sub - stories. the first story was related to iceland ’ s boom - bust cycle and problems with macroeconomic management in small, open, and financially integrated economies. this is a story that has played out many times around the globe, and many of its elements have been seen before in iceland. it might have been somewhat more extreme this time around, but it wasn ’ t fundamentally different. strong capital inflows that met with an insufficient policy response and contributed to huge imbalances in the domestic economy were a key part of the story. i will come back to this later. the second story was the rise and fall of three cross - border banks operating on the basis of eu legislation ( the european “ passport ” ). this story was much more unique, as it was part of the first banking crisis in europe since the eu single market was formed in the early 1990s. taking advantage of this framework and the prevailing international conditions of ample and cheap credit, these banks grew phenomenally, in less than five years, to almost ten times iceland ’ s gdp, with most of the expansion being crossborder – or maybe more aptly put, off - border, as the bulk of both financing and investment took place abroad. the result was very big fx - denominated balance sheets with the usual maturity transformation that banks, as we know them, are all about. however, the safety net that we have in national settings to back them up, including lolr facilities, was not there. it was an accident waiting to happen, and so it did. i will be very brief on how the failure of these cross -

and p. lowe ( 2002 ), asset prices, financial and monetary stability : exploring the nexus ”, bis working papers, no. 114. bordo, m. and o. jeanne ( 2002 ), “ monetary policy and asset prices : does “ benign neglect ” make sense? ” international finance, 5 ( 2 ). adrian, t. and h. s. shin ( 2008 ), “ financial intermediaries, financial stability and monetary policy ”, paper presented at federal reserve bank of kansas city ’ s symposium, jackson hole, august 2008. leverage. given the interlinkages existing in the global system, today this is true not only in the anglo - saxon systems, but also in the more bank - oriented european context. therefore, while monetary policy should continue to focus on delivering price stability, it should aim at a greater symmetry throughout the cycle and cannot afford to neglect the modifications and innovations affecting the structure of the financial system. we should not, however, underestimate the enormous informational challenge we have to confront. we need to improve our analyses and tools to be able to better assess the risks of a systemic crisis, quantify the effects that our actions may have to mitigate those risks and develop a deeper understanding of the two - way linkages between the financial and real sectors. in this respect, a closer interaction between macroeconomic and macroprudential analyses is essential. this requires stronger cooperation and information sharing among authorities both domestically and cross - border. moreover, greater transparency and improved disclosure practices in the private sector are necessary to be able to fully assess the conditions of the financial system and formulate the appropriate monetary policy. in this sense, monetary policy and policies to achieve financial stability are closely linked. the crisis we are facing is one of the most severe and complex of our times. the challenges will be substantial : restore price stability that would support growth, and ensure that the needed adjustments in bank and households balance sheets and in internal and external macroeconomic imbalances take place in an orderly manner. this will require action on the monetary, fiscal, and regulatory front. it will also require decisive action by the private sector to repair balance sheets, strengthen corporate governance, and improve the functioning of markets. history has repeatedly shown that needed reforms are ignored until a crisis forces action, and that the will to reform quickly dissipates after the crisis has passed. this crisis is no different, and this is an opportunity to strengthen the structure of the financial services industry