A rate hike in the present that is consistent with current conditions contributes to lower interest rates further ahead. Sometimes this happens very quickly — for instance, short-term central bank rates rise, causing longer-term rates to fall because the rate hike results immediately in lower inflation expectations. There are a number of examples where a rise in central bank rates leads to lower long-term rates rather quickly. 4  In the speech I gave here two years ago, I showed that real interest rates have fallen steeply in the past two decades, both in Iceland and internationally. I pointed out that the longer inflation expectations remain at target, the longer the propensity to save remains high, the more domestic debt levels fall, and the longer we have a positive net external position, the longer this trend could continue in Iceland. That still applies today. Last Friday, the Bank announced a reduction in the special reserve requirement (SRR) on capital inflows into the bond market and into high-yielding deposits, which was imposed in June 2016. The SRR was lowered because the interest rate differential with abroad has narrowed and the exchange rate of the króna has fallen. This was fully in accord with repeated statements by the Bank; i.e., that the premises for lowering the SRR would grow stronger, other things being equal, as the interest rate spread narrowed and the exchange rate fell.
For example, a study from a few years ago estimated that to comply with Basel III for a midsize European bank would require up to 200 full-time jobs.6 That is not per se a problem, but one has to look at it in the context of the current environment facing banks. If banks are simultaneously aiming to cut costs to restore profitability, while raising the resources they dedicate to compliance, there could be a consequence elsewhere: for instance, IT resources may be diverted away from innovation. That would hinder the process of technological adaptation that is key for their long-term viability. So I would argue that regulators should be mindful of the burden they are placing on banks and the potential unintended consequences. If banks are to adapt effectively to the new regulatory environment, they also need clarity on what it will look like. The risk of a prolonged period of regulatory reform – and remember the current phase has been ongoing since 2009 – is that it creates a moving target, which in turn prevents the industry from settling into sustainable new business models. To give just one example, some banks responded to the crisis by switching to a vision of retail deposit-funded subsidiaries, which was also supported by the initial wave of regulation, for example the Net Stable Funding Ratio. Now, with the introduction of the Total Loss Absorbing Capital rules, they may be forced to reconsider those business models as they will need to issue more unsecured long-term debt.