Section 4 highlights the  1  “Innovation and Integration in Financial Markets and the Implications for Financial Stability”, Rob Hamilton, Nigel Jenkinson and Adrian Penalver, pp. 226-250, The Structure and Resilience of the Financial System, eds Christopher Kent and Jeremy Lawson, Reserve Bank of Australia, November 2007. 2  See for example, the Bank of England Financial Stability Report, October 2007 and the Bank of England Financial Stability Report, April 2008. 3  See for example World Finance and Risk Management, delivered at Lancaster House 25 September 2002. 4  Referring to derivatives in the Berkshire Hathaway Inc. 2002 Annual Report. BIS Review 93/2008  1  obstacles to fulfilment of that vision given the imperfections in financial markets. Lessons for the future and possible policy responses are discussed in Section 5, while Section 6 concludes. Section 2: Trends in financial innovation 5 The pace of change in financial markets in recent years is truly remarkable. A few statistics help to illustrate this point and set the scene: •  The outstanding value of interest rate swaps and other derivatives reached almost $ trillion or some 11 times annual global GDP by the end of 2007, according to the BIS. Ten years ago the value was around $ trillion (2 ½ times GDP) (Chart 1). The global derivatives market expanded almost 50% during 2007.
This complicates the compilation of balance of payments statistics, in particular on factor income and factor expenditures, and on the stock of foreign assets. Official data shows foreign assets at market value where market prices are readily available. Otherwise, assets are recorded at their book value. In an article in the Central Bank’s most recent Monetary Bulletin 1 , an attempt is made to estimate the market value of inward and outward foreign direct investment using methods developed in other countries. This is done by estimating the likely market value of assets that do not have a readily available market price. The result of the calculation is that rather than being negative by 120% of GDP, the international investment position was negative by less than 30% of GDP at the end of quarter III of 2007. The large difference stems not the least from the fact that assets of Icelanders abroad are much larger than those of foreigners in Iceland. The lower figure is not necessarily correct. However, it shows that there is an overriding likelihood that the large negative net international investment position of Iceland is exaggerated in the official statistics which are compiled in accordance with IMF standards. The Icelandic economy is at crossroads. It is quite evident that the expansion of recent years is coming to an end. The forecast issued by the Central Bank on April 10 envisages a contraction of GDP in 2009 and 2010. The Ministry of Finance forecasts a milder and more short-lived contraction.