But the role of capital is primarily to reduce the risk of a bank failing at all. When the bank suffers losses it should have a capital buffer to meet them and thereby be able to continue its operations. What this means for the banks in the end, as for the rest of us, is that they must try to earn more money than they spend and have sufficient reserves to cope with the periods when they don’t. The banks manage this by constantly assessing the risk that a borrower will experience difficulties in meeting interest payments or paying off the loan. If this risk increases, the bank leaves a good margin for it by adjusting its lending or allocating reserves for potential losses. But as borrowers are affected by so many factors that are difficult to judge – for instance, economic recessions have very different impacts on different sectors and geographical areas – it is easy for the bank’s losses to become larger than expected. The minimum capital required by the regulations should act as a buffer against such unexpected losses. It is necessary for everyone to be convinced the bank will survive in order for it to survive. If the bank is perceived as unsteady, the supply of money will be cut off. A lack of sufficient capital buffers can easily shake confidence in the bank. And this was exactly what happened when the crisis loomed large. People were uncertain how badly off the banks were.
This is money we could have used for consumption and welfare. And let us remember that this is just one of the effects. Add to this the reduction in wealth in the form of falling values of companies, financial instruments and other assets. Contagion effects in a globalised financial market The origins of the crisis lay in US subprime mortgages. Although Swedish banks had very little exposure to this type of asset, the crisis nevertheless affected them. Like the Swedish economy as a whole, the Swedish financial system is very dependent on other countries. For example, only half of the banks’ funding is deposits from private individuals, companies and institutions in Sweden. The rest is borrowed on the market, and a large part of this on international markets. Moreover, most of the funding is relatively short term. This is not unique to Sweden. The advantage is that it reduces the banks’ funding costs, which in turn  2  BIS Review 159/2010  makes it cheaper for households and companies to borrow money. But there are also disadvantages. As the banks have made themselves more dependent on the outside world, they have of course become more vulnerable to problems arising abroad. When the international money markets slammed on the brakes in autumn 2008 the Swedish banks’ funding was immediately affected. Not least because they had borrowed money in the short term. So unlike the crisis of the 1990s the crisis we have just experienced is largely an imported one.