##udential measures. the institutional framework and the formulation of the measures vary. macroprudential policy will by its nature vary across countries. the credit cycle and systemic risk vary over time and across countries. that being the case, neither banks nor other economic agents should be surprised that macroprudential policy in norway differs from that of surrounding countries. in many countries, the central bank has a prominent role in macroprudential policy. monetary policy objectives and macroprudential objectives are not the same. monetary policy is aimed at securing low and stable inflation and is the first line of defence against cyclical fluctuations. macroprudential policy is aimed at strengthening the resilience of the financial system and curbing financial vulnerabilities that build up in the economy over time. macroprudential policy and monetary policy nevertheless share many features. in norges bank, we can build on the experience of monetary policy when providing advice on the size of the countercyclical capital buffer for banks. both macroprudential policy and monetary policy must be based on an assessment of the state of the norwegian economy and developments in credit, inflation, output and employment. the buffer works through banks, as does monetary policy. the analysis of the capital buffer therefore has much in common with the analysis we perform when setting the key policy rate. in our monetary policy analysis, we must assess whether output and employment lie above or below their long - term trends ; in our financial stability analysis, we must assess whether credit lies above or below its long - term trend. both policy areas must give weight to the risk of a build - up of financial imbalances. the communication of monetary policy also offers some lessons. whereas monetary policy was previously veiled in secrecy, we are now open about our view of the likely future interest rate path. the theoretical foundation for transparency builds on the notion that prices are sticky. adjusting prices goes smoother if central banks ’ response pattern is known. market participants then have a solid basis for forming expectations about future interest rates. the same line of reasoning may be valid with regard to transparency about our advice on the countercyclical capital buffer. it takes time for banks to adapt to changes in capital bis central bankers ’ speeches requirements. a predictable policy will facilitate the adjustment process. the size of the friction is difficult to assess. banks tend to restrict themselves to a very limited number when they present their options for increasing capital ratios. if banks choose to raise new equity capital

reliable estimates of the size and portfolio composition of major counterparties were lacking and that improved credit risk management techniques were needed in two key areas : credit and market exposure measurement, and counterparty due diligence. let me be a bit more specific about some of the weaknesses found in credit risk management techniques. for example, some institutions routinely performed credit assessments using sparse, often unaudited financial information from valued customers, some of which had recorded substantial profits in previous years. moreover, institutions that received intermittent financial statements and had infrequent contacts with these counterparties were left to make periodic credit assessments using stale information in a rapidly changing market. this insufficient information impeded the setting of prudent credit limits and terms, including collateral requirements and contract covenants. many risk managers also failed to account fully for the risks involved in new financial products. non - traditional products, such as equity repos and credit derivatives, challenged existing credit – 2 – analysis systems and methodologies. in addition, relatively few financial institutions attempted to stress test credit exposures and even fewer anticipated a market environment as adverse as what we experienced in the third quarter. for these and most other institutions, the rush to mitigate and reduce their exposures, particularly to highly leveraged institutions such as hedge funds, quickly resulted in the widespread withdrawal of all lending activity to some troubled sectors, regardless of an individual counterparty ’ s financial condition. while these decisions undoubtedly were intended to reduce risk and avert losses, they also served to exacerbate already extraordinary financial market fragility. given that the task of assessing and managing risk is not going to get any easier as we move into the 21st century, let me now turn to some of the issues that i believe will challenge financial institution managers in the coming year and beyond. one issue is the increasing integration of banking, securities and insurance services ; a second is the increasing pace at which capital moves across international borders ; a third, the year 2000 problem ; and a fourth, the challenge of bringing improved risk management techniques to business operations as a whole, including the trading rooms. this is particularly important for participants in the rapidly changing fixedincome markets. first, the integration of previously separate financial services means that institutions must be prepared to manage risks across a far wider range of products, business units, and counterparties than they have been accustomed to doing. in the securities lending markets, for example, an increasing number of firms are accepting equities as collateral for financing