According to the latest Triennial Central Bank Survey of foreign exchange and derivatives market activity conducted by the Bank for International Settlements (BIS) in April 2013, total global average daily turnover across overthe-counter foreign exchange instruments – including spot, forward, swap, and option transactions – was estimated to be more than $ trillion, an increase of nearly 60 percent since 2007. 2 This trading volume dwarfs the U.S. fixed income market, where average daily turnover at the end of 2013 was about $ billion. 3 Within this large market, a broad range of foreign exchange products is traded each day by a diverse set of market participants for a wide variety of reasons. Derivatives are the largest component of global trading in the FX market, accounting for about 60 percent of turnover in 2013. They play an important role in helping transfer a wide variety of risks from entities that cannot or do not want to bear it to those that can and do – including risks associated with hedging cross-border exposures or positions in other markets, such as fixed income – or to provide a source of funding to help meet liquidity needs. The most actively traded derivative product, foreign-exchange swaps, accounted for about 40 percent of all trading activity in the global FX market in 2013, serving as a critically important cross-currency funding tool for a wide variety of market participants.
This story was much more unique, as involved the first banking crisis in Europe since the EU single market was formed in the early 1990s. Today I am not going to talk about the build-up to these events, and I will have little to say about the second story. I have expanded on both in various publications and speeches that I can refer you to. Instead, I am going to talk about what happened to the Icelandic economy afterward – its deep recession and its recovery – and then reflect on some of the policy challenges that still face us. But let us first reflect on the distance that has been travelled since that fateful autumn of 2008. Iceland’s financial sector was crumbling, and the authorities had to take extraordinary measures to keep basic domestic banking services up and running, including letting the international part of the banking system go into resolution, wiping out all equity in the banks, and removing their managers. Many expected the sovereign to default on its obligations, which would have left Iceland shut out of international capital markets for years. A key aspect of crisis management was therefore to ring-fence the sovereign from the failing banks and minimise the socialisation of private sector losses. And Iceland was well on its way into its deepest post-war recession, where GDP contracted by 12.5% from its peak in the fourth quarter of 2007 to its trough nine quarters later, in the first quarter of 2010.