There are nominal and real factors that affect commodity price developments. The most important real factor is due to the low price elasticity of not only supply of but also demand for these items. Because of low elasticity, a minor change in supply has the potential to affect market prices significantly. Likewise, a minor change in future real growth prospects has the effect of shifting the demand with a potential of large market price changes. This explains the real sources of commodity price volatility which is recently observed. Regarding nominal sources of volatility, most commonly cited explanations are related to monetary policies of major central banks and the structure of financial markets in commodities. I will elaborate more on real factors that is the lack of sufficient real supply increase in order to meet booming real demand from the developing world. The high growth potential in developing countries suggests that demand pressures are likely to stay with us over the years to come. Combined with the massive financial flows fueled by the exceptionally loose monetary policies, commodity price volatility will probably remain as a major challenge in the years ahead. I believe the key solution here lies in productivity increases in agriculture and energy in the medium term. Regarding agriculture, this necessity is much more evident in emerging markets – in order to keep up with the demand growth, considering the higher share of food in the consumption basket.
Banks must not be able to reduce capital below a minimum level even if they extend loans that, according to the models, seemingly involve low risk. Second, regulation must to a lesser extent contribute to amplifying cyclical fluctuations. With losses now rising, as a result of the abrupt and pronounced turnaround, banks must increase equity capital. Consequently, the rules governing capital requirements amplify cyclical fluctuations. The rules must therefore require banks to build up strong capital buffers over and above the minimum requirement in normal times. Then the banks would not have to  4  BIS Review 60/2009  increase capital when a turnaround occurs, but on the contrary be able to absorb losses. This will counteract the need for banks to ration credit in adverse periods. Many Norwegian banks do not have sufficient buffers today to safeguard their own, their shareholders’ or the economy’s best interests. Third, banks’ funding methods make them vulnerable. Earlier, the two main sources of bank funding in Norway were retail and wholesale deposits. In recent years, banks have borrowed heavily in both domestic and foreign markets. During the crisis, this proved to involve high liquidity risk for banks. In the future, in regulations and in practice, deposits must again take precedence as the largest funding source for banks. We also anticipate that bonds collateralised by high quality mortgages will become important. The credit swap arrangements can be seen as building a bridge to such a market.