mar guðmundsson : capital flows and fragmentation of the international financial system speech by mr mar guðmundsson, governor of the central bank of iceland, in session i in the conference “ fragmentation in the international financial system – can the global economy become one again? ”, organised by the central bank of the republic of turkey and the reinventing bretton woods committee, cappadocia, turkey, 14 july 2012. * * * for the most part, i will discuss some flaws in the international monetary and financial system ( s ) ( imfs ) and in the european union ( eu ) framework for cross - border banking and financial stability as they relate to both net capital flows and vulnerabilities in gross capital positions. my perspective on these issues is that of a policy - maker from a very small, open, and what used to be financially integrated economy, but it is also informed by the work i was involved in during my tenure at the bank for international settlements. the current international and monetary and financial system is in some sense a non - system, a hybrid of miscellaneous exchange rate regimes and diverse rules on cross - border capital flows and activities of financial institutions. this opens the door to country choices that, in the aggregate, cause and perpetuate global current account imbalances. this problem and its solution have been discussed extensively, and i will not dwell on that topic here. instead, i want to pose this question : supposing that all countries had free capital movements, freely floating exchange rates, and first - rate macroeconomic policies aimed at internal balance, would everything then be fine, at both the national and global level? i think there are strong indications that it would not be. there are a few reasons for this. first of them is the tendency of exchange rates to move away from equilibrium values for extended periods, with sharp corrections at the end of the process and with excess volatility throughout. the research on this phenomenon is still ongoing, but there are strong indications a number of factors suggest that the process is related at least partly to how asset markets function and how expectations are formed, and would not disappear even if macroeconomic policies were perfect. there will be net capital flows associated with this process, as well as swings in current accounts and effects on domestic financial systems that can ultimately lead to serious financial instability. in a small, open, and increasingly financially integrated economy, the process runs as follows : domestic interest rates at the longer end of the maturity

arnor sighvatsson : guidelines issued to financial institutions due to non - binding clauses linking loans to the exchange rate introduction by mr arnor sighvatsson, deputy governor of the central bank of iceland, about guidelines issued to financial institutions due to non - binding clauses linking loans to the exchange rate, reykjavik, 1 july 2010. * * * this morning the central bank and the financial supervisory authority issued guidelines to financial undertakings in order to instruct them on how to respond to the supreme court judgement on non - binding exchange rate linkage clauses. with these guidelines, the supervisory bodies concerned declare that their unequivocal understanding of the situation resulting from this supreme court decision is that, in cases involving loan agreements that have been ruled unlawful, the settlement and repayment of those agreements shall take account of articles 4 and 18 of the act on interest and price indexation, no. 38 / 2001, unless the parties agree otherwise. the guidelines are intended to create stability in financial market transactions and promote a secure and effective financial system. the financial supervisory authority and the central bank are required by law to ensure financial system stability, which is a matter of vital public interest. with the issuance of the present guidelines, these institutions are acting in accordance with the legal obligation resting on them. the guidelines are based on the above - specified supervisory bodies ’ considered opinion that there is no legal or substantive rationale for the maintenance of the previous interest rates ( which were determined with reference to foreign interbank rates ) after the portion of loan principal bearing such interest has been uncoupled from the exchange rate of the currency concerned by means of the recent supreme court decision. the supervisory bodies are of the opinion that such an interpretation of the supreme court judgement, were it implemented to the fullest extent possible, would represent such a heavy blow to financial undertakings ’ equity that the treasury would be forced to contribute substantial new capital to them. that expense would ultimately be borne by other members of society. the method recommended by the central bank and the financial supervisory authority will preserve the stability of the financial system even in the event that a majority of loan agreements with exchange rate linkage clauses are deemed unlawful, although it could take quite a long time to determine this conclusively. financial undertakings ’ equity will sustain a considerable blow in any case, if judgements by the supreme court ultimately extend to a large portion of their loan portfolios. offsetting this is the fact that uncertainty will have been eliminated, which could