Without that, human and financial resource allocation either side of the ring-fence will become blurred. For example, without separate debt issuance for retail and investment banking, the cost of debt for a big bank will be a blended mix. The implicit subsidy in funding costs would then remain and with it one of the main distortions associated with too-big-to-fail. Only time will tell whether cultural separation can be achieved under the existing structural reform proposals. In the go-go years, will these reforms be sufficient to prevent the grass always appearing greener on the riskier side of the (ring-)fence? This is the acid test of the structural reform agenda. Where next? Progress has been made over the past few years towards eliminating too-big-to-fail, with further progress on implementation planned. But today’s task is even more daunting than before the crisis. The big banks are even bigger. The system itself is more concentrated. And  BIS central bankers’ speeches  7  despite reform efforts, the market’s best guess today about tomorrow’s implicit subsidy is farlarger than before the crisis struck, at over $ billion per year (Chart 3). The market believes that illicit state promise is even more likely to be kept. The wrong conclusion to draw would be that existing reforms have failed or are unnecessary – quite the contrary. Rather it is that these reform initiatives, while necessary, may be insufficient to eliminate the too-big-to-fail externality. If so, what are the alternatives? Several have been mooted. Re-sizing the capital surcharge is one possibility.
The Central Bank has been active in promoting the development of the financial system and financial markets in Iceland and we have sought to adopt the methods of monetary management that have been developed in other advanced industrial countries. In 1998, we modified the instruments and operating procedures of the Central Bank along the lines that had been developed for the future European Central Bank. The Central Bank of Iceland levies a reserve requirement on credit institutions, operates an overnight facility and offers a deposit facility. The main operating instrument of the Bank is the repo rate. Auctions of 14 day repo contracts are conducted once a week. By adjusting our instruments and methods, we created a similar operating environment for Icelandic banks as those that prevail for banks in the Economic and Monetary Union of Europe. I should add that we are in the process of adapting our payments and settlement systems to the norms of our neighbouring countries. This includes, among other things, the establishment of an RTGS system for large-value payments. I mentioned that the main target of the Central Bank is the maintenance of low inflation. That is a long-term target. Our intermediate target is a fixed exchange rate. A more appropriate description of our exchange rate policy is to refer to it as a fixed but adjustable peg. Since 1995 we have operated with a fluctuation band around the central rate of plus/minus 6%.