Már Guðmundsson: Sovereign risk – a world without risk-free assets? Remarks by Mr Már Guðmundsson, Governor of the Central Bank of Iceland, in a policy panel at a seminar on “Sovereign risk – a world without risk-free assets?”, Bank for International Settlements, Basel, 8–9 January 2013. *  *  *  I would like to cover three issues in my remarks. First, I will reflect a bit on the title of the seminar and some of the more specific questions directed at this panel. Second, I will discuss the nexus between sovereign risk and banking fragility, using Iceland as a case study – after all, the Icelandic experience is probably the reason that I am taking part in this interesting seminar in the first place. Third, and again with reference to the Icelandic case, I will reflect on the connection between sovereign ratings of advanced countries and actual sovereign defaults. The title of this seminar is Sovereign risk: a world without risk-free assets? As has been repeatedly pointed out, there is, strictly speaking, no such thing. The default probabilities of even the strongest sovereigns are not zero, and they increase as the horizon gets longer. Furthermore, the real income stream of nominal government bonds is uncertain.
The need for this involvement is heightened by the entry into force in 2018 of the new standard (IFRS 9) under which banks will switch from using the concept of incurred loss to that of expected loss in order to calculate the credit portfolio provision. This standard is undoubtedly an improvement on the current situation, since it enhances the measurement of the risks of loans and receivables. At the same time, it significantly increases the complexity of calculating provisions and, thus, increases the risk of heterogeneous application across banks, which is something the supervisor should be aiming to mitigate. The work under way in the Basel Committee on this matter is therefore very timely. My comments so far imply that there are in practice significant obstacles to satisfying the legitimate expectations that a rigorous and granular supervision will help moderate the intensity of the regulatory changes needed to promote financial stability. BIS central bankers’ speeches  3  The regulatory frameworks in force and different supervisory cultures, along with the difficulty of becoming more involved in accounting practices, often place considerable limits on the intensity of supervision attainable. This explains why the actions of the authorities to prevent financial crises largely rest on the definition of clear and demanding prudential standards to underpin the work of supervisors.