Given how much debt banks will need to refinance or repay to the authorities around the world over the next few years, the Bank is keen – as reflected in the recently published minutes of the Chancellor’s Council for Financial Stability – that individual banks agree indicative refinancing plans with their supervisors; and that at least aggregate national conditions be shared amongst international peers. That would help to avoid each bank thinking that it can  2  BIS Review 21/2010  delay its effort, risking an almighty scramble in eighteen months or so when official-facilities will be running off. As household sector saving has risen and as banks have deleveraged, government borrowing has increased very sharply as it helped to absorb the macroeconomic shock. Without too much exaggeration, this can be thought of as a rescheduling of private sector debt facilitated by the only balance sheet currently strong enough to bear it – HMG’s. But, like financial services, the public sector had accounted for an increasing share of measured output in the run up to the crisis. And since a good deal of that was debt financed, this source of support is not unlimited. Indeed, those two sectors have to be part of the process of rebalancing demand and activity in the economy over the years ahead. Overall, the rebuilding of balance sheets and the rebalancing of demand pose a downside risk to the outlook for activity. Effective supply, and inflationary pressures Repair of balance sheets will affect the path of demand. What of supply?
The conditions for opening up that access are rapidly being created in the wake of the Second Review of the IMF programme, as is witnessed by the development of the credit default swap spread of the Icelandic sovereign and the fact that the rating outlook has improved. But what about the pension funds? They were hit very badly, of course, as their equity stakes in the fallen banks became worthless overnight, the value of bank bonds collapsed, and asset prices of all kinds tumbled. The result was that the real rate of return on the funds was negative to the tune of 22% in 2008, and their assets as a share of GDP fell from 134% in 2007 to 119% last year. But let us remember that part of this is a correction. The asset values of the boom and the associated rates of return on pension funds, as well as banks, had a significant element of froth. To some extent, they were never real. 4  BIS Review 63/2010  We always knew that this kind of shock was the major risk facing fully funded pension systems. But the system is still here. It took a hit, but it withstood the shock. So my basic belief in the strengths of the Icelandic pension system and similar systems around the world is still intact. But that is provided that we learn the lessons of the financial crisis and make it a once-in-a-lifetime event. We need to learn the lessons on incentives and risk management.