Financial crises have typically been associated with boom and bust cycles in asset prices and credit. Due to sharp growth in house prices and household debt in several countries in recent years, the question of whether monetary policy should be used to mitigate such developments has received increased attention. In the light of these developments, I would like to address four main questions. What do we mean by financial stability, how do we analyse it, how do authorities cooperate in order to support it, and finally, what instruments are available to secure financial stability? What do we mean by financial stability? Despite increasing focus during the last decades, uncertainty about how best to define the concept ‘financial stability’ remains1. In order for households and enterprises to obtain optimal consumption and investment over time there has to exist a well-functioning financial system that can intermediate between savers and borrowers, carry out payments and redistribute risk in a satisfactory manner. This promotes an efficient allocation of real economic resources across different activities and over time. From this point of view, financial stability can be defined as a situation where the financial system is able to meet these requirements, and thereby enhance economic performance and wealth accumulation A more narrow approach is to define financial stability in terms of what it is not, that is a situation in which financial instability impairs the real economy.
Without formal supranational solutions in place, it is all the more important to ensure cooperation between the central banks and supervisory authorities involved. The fact that a large share of the financial institutions in the new EU member countries are foreign-owned makes this issue even more relevant. In June 2003, the governors of the Nordic central banks signed an agreement on the management of a potential financial crisis in a Nordic bank with activities in two or more Nordic countries. The agreement contains procedures for the coordination of crisis management between the central banks. The Nordic supervisory authorities have drawn up a similar cooperation agreement. One particular problem in the Nordic region is the differences in the countries’ deposit guarantee schemes. The different schemes vary both with respect to guaranteed amount and type of deposit covered. However, these differences are also widespread across Europe and some convergence of rules and operating procedures is certainly long overdue. What instruments are available to secure financial stability? Monitoring and analysis of the financial system result in an assessment of the current situation regarding financial stability. This leads to the question: what instruments are available to enforce and secure financial stability? We can distinguish between preventive measures and measures for crisis resolution. Of relevance to the latter is the role of the central bank as the lender of last resort. In some countries this role was the main reason for establishing the central bank in the first place.