•  Relying solely on securities as collateral is not enough; a picture must also be obtained of the borrower’s total commitments. •  The LTCM crisis demonstrates that credit assessments must include a larger element of readiness for extreme events. Models based on historical events were incapable of foreseeing the debt moratorium in Russia and the resultant slump in virtually every market. Neither could they envisage that market liquidity would dry up to such an extent that the banks would not be able to dispose of their loan collateral without eliciting a very steep price fall. The banks need to augment their risk models with stress tests— assessments of the direct and indirect effects that unusual market developments would have on their current positions. •  Banks must improve their risk management and knowledge of different forms of risk but so must the supervisory authorities. •  A further question concerns the adequacy of existing laws and regulations. Are there things we have missed? As I mentioned earlier, intensive efforts are being made to improve the rules. Having said all this, we must also recognise that the extensive work that is continuously being done to strengthen the financial system does not mean that the system will be made completely immune to crises. The work must focus on mitigating the effects and trying to ensure that crises which do occur are less extensive and socially costly than those we have experienced in recent years.
Mr Bäckström looks at the Riksbank and financial system stability and comments on the LTCM case Speech by Mr Urban Bäckström, Governor of Sveriges Riksbank, to the Swedish Economics Association in Stockholm on 25/2/99. Financial stability is a topical subject in the light of events in the past yeara year that saw continued financial problems in Asia, the devaluation of the rouble and suspended payments in Russia, considerable turbulence in western financial markets and financial unrest in Brazil. What happened last autumn, when it was considered that problems for a single playerthe hedge fund Long Term Capital Managementmight create grave difficulties for the financial system in the United States, highlighted risks of a new type. The LTCM case can be seen both as an extreme example of what could happen in Sweden’s financial markets and as a serious reminder that the continuous development of financial markets is liable to give rise to new risks. The suspension of payments in Russia and its consequences should likewise lead us to reflect on the risks in the system. Today I shall be discussing the problems behind last autumn’s events in the U.S. market and the fact that a systemic crisis was judged to be imminent. First, however, I shall briefly sketch the background and explain stability’s central importance for the Riksbank. Background There is nothing new about financial crises. Over the centuries they have repeatedly hit financial systems in the industrialised world, as well as in less developed countries.