On the other hand, a speculative position against the share price of the banks tended to weaken the króna, as the banks were listed in Iceland and their equity denominated in krónur. Furthermore, as the banks’ official accounts and equity were denominated in Icelandic krónur, while ⅔ of their balance sheet was in fact denominated in foreign currency, they tended to hedge their equity, which, during the weakening phase of the króna, tended to weaken it further. These relationships emerge clearly in the graphs below, which show the strong correlation between international liquidity conditions, as measured by an index constructed by the Bank of England, the exchange rate of the Icelandic króna and share prices of listed financial institutions.
This over-indebtedness was moreover accompanied by a strong bias towards the construction and real estate development sector and, inevitably in an economy as strongly banked as Spain, this also led to excessive growth in bank lending and excesses in banks’ risk concentration. The relative ease with which these debts built up and their subsequent effects on activity, employment and financial stability were not, in any event, an exclusively Spanish phenomenon. Indeed, these and other similar developments have given rise to widespread initiatives at the international level to strengthen the economic policy tool box, with a new instrument – namely macroprudential supervision – being incorporated to head off this type of situation. In any event, the losses in competitiveness and excessive debt led to a large-scale imbalance in our foreign trade, resulting in a deficit of 10% of GDP in 2007 and requiring the resort to large volumes of external saving to ensure trade financing. But other elements of fragility emerged with the crisis. The worsening macroeconomic scenario and, in particular, the collapse in employment had a most adverse influence on public finances. The characteristics of labour market regulation meant that the effects of the adjustment to the sudden change in the business cycle fell basically on employment, and hardly on wage conditions or on greater hiring flexibility. In turn, the marked deterioration in public finances revealed weaknesses in the institutional workings of the public sector; in particular, the insufficiency of the disciplinary framework in place to ensure compliance with budget targets.