Losses on subprime mortgages in the US shattered confidence in the entire financial system. Financial institutions started to doubt their counterparties and interbank lending came to a halt. Experience shows the need for tighter regulation of systemically important banks. This can for example be achieved by introducing higher bank capital and liquidity requirements for such banks. The capital requirement for mortgage lending should to a larger extent reflect the overall risk of such loans. 1  See Carmen M. Reinhart and Kenneth S. Rogoff (2009): “This Time Is Different. Eight Centuries of Financial Folly”, Princeton University Press. BIS Review 69/2010  9  Justified criticism has been levelled at international banks. The focus is now shifting to government fiscal management in many countries. Fiscal slippage seems to have been considerable in some European countries in particular. EU budget policy guidelines have been diluted and have not been adhered to. Countries have experimented with budget frameworks and have debt-financed public investments, which require operating and maintenance costs but yield little income. With already large deficits, the crisis has destroyed state finances in many countries. Economic developments over the next 5–10 years will be marked by the tightening measures that will now have to be implemented in these countries. However, there are exceptions. State finances in Nordic countries are in order, which provides a better starting point. With ample state coffers, the Norwegian economy was to a considerable extent insulated from the effects of the financial crisis in 2008 and 2009.
In addition, a number of investment projects are extremely foreign exchange-intensive because of imports. The króna could depreciate as a result, with heavy outflows of foreign currency, even if there were ample opportunities for investment. This is the problem the liberalisation strategy is attempting to solve. Emphasis is placed on protecting the foreign exchange reserves by converting short-term claims against domestic entities to long-term investments to the extent possible. The Central Bank acts as an intermediary, and the auction format ensures that only a small portion of the foreign exchange reserves are in play at any given time. The auction format also ensures that transfers of banking system liquidity will not be large enough to jeopardise the system’s stability. The foreign exchange reserves are protected as well by the requirement that investors bring foreign currency into the country and exchange it for krónur in the domestic market. This will offset the foreign exchange outflows that often accompany new investment. Another important aim of the strategy is to ensure short-term Treasury financing. Even though significant progress has been made in controlling the fiscal deficit after the crash and halting the accumulation of unsustainable debt, it is important not to underestimate the current dependency of Treasury financing on the capital controls. More than half – and, in some instances, as much as ¾ – of the stock of short-term Treasury bonds is held by nonresidents.