The main explanation is perhaps that interest rates abroad were lower than in Sweden. Borrowing in a foreign currency was perceived to be cheaper. While some households and firms may have wondered why and found that the higher Swedish rates were simply a risk premium to cover the possibility of a future devaluation, the consequences of this analysis were generally ignored (a devaluation would have increased the amount of a loan expressed in Swedish kronor, making the burden of repayment heavier). The fixed exchange rate policy was perceived as credible, at least by these borrowers. They were lulled, or lulled themselves, into thinking that the exchange risk, even though it was occasioning higher interest rates than in the rest of the world, would be absorbed by the Riksbank. That meant they could try to benefit from the interest rate differential with impunity. As many of these foreign currency borrowers were players who could not afford loans in Swedish kronor, they had no margin when the liabilities became more costly after the krona’s fall and this accentuated the problems. 3  BIS Review 127/1999  What lessons can we learn? I have now identified three features of the Swedish crisis: rising asset prices, a strong expansion of credit and short-term borrowing in foreign currency. These three factors have in fact preceded almost all the financial crises that have hit various countries in the past decade. This does not apply to last autumn’s turbulence over the Russian suspension of payments and the LTCM hedge-fund problems.
We must also work to mitigate any effects and try to ensure that crises which do occur are not as extensive and economically costly as those we have experienced in recent years. The objective, in other words, must be to combine the necessary regulation and supervision of the markets with the benefits that a well developed financial system can confer. The regulation and supervision of financial firms are necessary for various reasons. But these functions must be carried out in such a way that they do not throttle the potential that can contribute to greater prosperity in the global economy. Conclusion Many countries have deregulated their financial systems in the past two decades. For the first time since the outbreak of World War One, capital is again more or less free to move across national borders. Moreover, major changes in communications and information technology have provided new methods and instruments for risk management. As a result of all this, today the financial system is more extensive and globalised than ever before. This holds even though capital flows relative to GDP were also large at the turn of the nineteenth century. At the time, however, it was other countries that received the flows, which also took a somewhat different form. The rapid pace of financial developments and internationalisation is really a logical consequence of the globalised production of goods and services, with the strong growth of cross-border trade in the world economy. These developments have accentuated the need of new financial solutions for firms and households.