mar guðmundsson : to what extent do international and eu reform proposals address the fault lines in cross - border banking? keynote address by mr mar guðmundsson, governor of the central bank of iceland, 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. * * * governor, chairmen and participants, let me begin by thanking the organisers for inviting me to address this impressive gathering and thus enabling me to visit this fascinating place. in my speech i will discuss the risks in cross - border banking that manifested themselves in the crisis and what has been done since to address them. the bottom line is that, at the global level, we had developed significant cross - border banking operations that were only very partly covered by the safety net of lender of last resort ( lolr ), deposit insurance and adequate resolution powers, and the associated regulation and supervision. i use the metaphor of a fault line to describe this. but first i want to tell you a little more about the origin of my perspective on these issues. it comes first from my tenure at the bank for international settlements ( bis ) from 2004 – 2009, where i was involved in work on these issues, with the bis international banking statistics providing a constant point of reference. but more importantly, it comes from my current position as a policymaker from a small, open economy where the collapse of three cross - border banks was the most noticeable event in the unfolding of the financial crisis that hit the country in 2008. the combined balance sheets of these banks was 10 times iceland ’ s gdp, and their combined bankruptcy, measured in terms of balance sheets, ranks second in size in the international history of corporate failures, only after lehman brothers. and this happened in a country that ranks among the smallest in the world. i will use the case of these banks to illustrate current problems with cross - border banking more generally and as a yardstick against which to measure current reform proposals. cross - border banking expanded significantly in the years prior to the financial crisis, as is witnessed, for instance, by the growth in cross - border banking claims measured by the bis international banking statistics. attending this growth was a steady build - up of cross - currency liquidity risk. such risk can take two forms : currency mismatches and maturity mismatches between foreign currency assets and liabilities. to take an example

literature – are the signalling effect and the portfolio balance effect. [ slide 7 ] signalling and portfolio balance effects of a large - scale … the signalling effect contributes to stronger anchoring of inflation expectations in line with the medium - term objective of price stability. this effect also contributes to reducing anticipated real rates. depending on the monetary policy reactions in the rest of the world, the signalling can also put downward pressure on exchange rates. the portfolio balance effect broadens the effects of the securities purchases to the whole financial system even if only a comparatively narrow range of high - quality securities are purchased by the central bank. with this effect, investors are encouraged to shift holdings into other asset classes – e. g. from sovereign to corporate bonds, from debt to equity, and across jurisdictions. this has an indirect effect on the prices and required rates of return in the financial markets as a whole. [ slide 8 ] ecb ’ s accommodative monetary policy overall, the ecb ’ s accommodative monetary policy lowers real interest rates and eases financial conditions in the economy, boosting demand. consumption increases and the lower cost of debt finance, reduced cost of equity and weaker exchange rates in combination contribute to making some investment projects profitable that were previously deemed unattractive. bis central bankers ’ speeches this supports private consumption through various channels. also, the lower cost of debt finance, reduced cost of equity finance, and the weaker exchange rate all contribute to making investment projects more profitable. [ slide 9 ] divergence in monetary policy cycles has weakened the euro the divergence in international monetary policy cycles is putting downward pressure on the external value of the euro. this development is partly a result of tightening monetary policy expectations on the other side of the atlantic. [ slide 10 ] renewed decline in oil price puts downward pressure … conditions in wide spectrum of asset markets have developed broadly as intended when the current cycle of monetary policy easing. however, the slowdown in emerging markets and recent sharp fluctuations in financial and commodity markets have brought some downside risks to the outlook for growth and inflation. the renewed decline in oil price puts downward pressure on inflation in the short run. [ slide 11 ] commitment to accommodative monetary policy stance … commitment to the accommodative monetary policy stance supports inflation expectations, thereby lowering the real interest rate. more recently, renewed downside risks have emerged and inflation expectations have decreased. however, owing to sharp fluctuations in financial and commodity markets, the governing council judged