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

stephen s poloz : release of the financial system review opening statement by mr stephen s poloz, governor of the bank of canada, at the press conference following the release of the financial system review, ottawa, ontario, 9 june 2016. * * * good morning. senior deputy governor wilkins and i are pleased to be with you today to talk about the june issue of the bank ’ s financial system review ( fsr ), which we published this morning. the fsr identifies financial system vulnerabilities and monitors how they evolve. it then looks at how those vulnerabilities could become risks to the financial system as a whole. turning vulnerabilities into risks requires a trigger – an event that interacts with the vulnerability and has a magnified effect on the financial system and the economy. so, we measure financial stability risk as a combination of the scale of the underlying vulnerability, the probability that a risk will be triggered and the estimated magnitude of the fallout if it is. since our last fsr in december, the global macroeconomic environment first deteriorated but then improved. the us economic recovery gained traction, and accommodative monetary policies helped stabilize global financial conditions. here in canada, the economy continues to work its way through the implications of low oil prices, even though prices have recovered some lost ground. the export recovery remains uneven, and has yet to translate into stronger investment spending. nevertheless, we remain confident that those forces are in motion in light of continued us expansion, past monetary policy actions and announced fiscal plans. more recently, the devastating wildfires in alberta pose a significant downside risk for near - term economic growth, but estimated insurance claims, while large, do not suggest a threat to financial stability. today ’ s fsr focuses on the same three vulnerabilities as our december report : • the elevated level of canadian household indebtedness, • imbalances in the canadian housing market and • fragile fixed - income market liquidity. we assessed these vulnerabilities in the context of four risk scenarios, namely : • a large increase in canadian unemployment brought about by a severe recession ; • a sharp jump in long - term interest rates driven by higher risk premiums, globally and in canada ; • a sudden rise in stress from china or another major emerging economy ; and • a prolonged period of very low commodity prices. the first two vulnerabilities, household indebtedness and imbalances in the housing market, have