It has been channelled directly through the banks as well as indirectly, for instance via hedge funds. A good many such funds have obtained large loans from banks in the industrialised countries and, in pursuit of favourable yields, invested the money in emerging markets. This indirect lending can be likened to the Swedish banks’ earlier lending to finance companies. This brings us to the nature of banking in a more profound sense. Traditional banking involves accepting deposits from the non-bank public and lending these funds to various borrowers. Moreover, the equity capital on which banking is based is small, which implies high leverage and low solvency. If all the banks’ capital had consisted instead of equity, incurred losses could have been handled more or less painlessly. With a large proportion of borrowed capital, however, there are liable to be chain reactions that successively spread through the banking system. It is precisely this that necessitates comprehensive, efficient supervision and a functional set of regulations in order to avoid unnecessary losses. That is also why central banks around the world have been assigned the function of safeguarding the financial system’s general stability. BIS Review 83/1998  -5-  What can be done? The current problems in the global financial system need solutions for both the short and the longer run. In the short run it is a question of resolving the acute crises. Work for the longer run must focus on the creation of an international rule system that prevents crises of this type from occurring.
Certainly there are a number of questions and challenges regarding future developments in the banking system and the regulatory framework for it, as has emerged in the recent White Paper on a Future Vision for the Financial System, but further discussion of that topic must await another opportunity. Early this month, Parliament passed legislation lifting restrictions on the remaining stock of offshore krónur, which amounted by that time to 84 b.kr., or just under 3% of GDP. This represented the final step in lifting capital controls on non-residents’ króna-denominated assets. The assets fell into two categories: so-called offshore krónur, on the one hand, and króna-denominated assets held by the failed banks’ estates, on the other. These assets combined amounted to 65% of GDP at the peak. We reduced that percentage to the current level through various measures taken in 2010-2017 — without disturbing the balance of payments or financial stability, without tapping the Bank’s reserves to an inordinate degree, and without significant legal repercussions. This success has been noticed, including internationally. Alongside the final liberalisation of offshore krónur, the special reserve requirement on capital inflows into the bond market and high-yielding deposits was lowered to 0%. This synchronised effort has delivered positive results. The 5  exchange rate of the króna has not been under pressure due to offshore króna outflows, and the Central Bank has not yet needed to use significant reserve assets in order to fulfil its pledge not to allow those outflows to weaken the currency.