An encouraging aspect of subsequent developments, however, is that the banks have begun to extend the maturities of their foreign borrowing, so that the gap between their short-term and long-term liabilities has narrowed in recent weeks. This is crucial, because it may be imprudent to place excessive faith in the availability of shortterm funding. In its letter, the Central Bank echoed cautionary remarks from the agencies that award credit ratings to the Republic of Iceland and other Icelandic borrowers in foreign markets. Ratings agencies have stated that their chief concern and the main constraint on upgrading Icelandic ratings - or even a potential reason for downgrading them - is the high external debt position of the economy. Since the Treasury has been retiring its foreign debt over the past few years, the ratings agencies’ comments are addressed elsewhere, in particular to the banks. Cautionary remarks based on such arguments should of course be heeded by all the banks in Iceland that have been borrowing abroad recently. It is in everyone’s interest to safeguard Iceland’s credit ratings and, where possible, strengthen them. Payment and settlement systems At the Central Bank’s annual meetings in recent years I have outlined the work it has undertaken in development of payment and settlement systems. Two types of payment system are in operation in Iceland, both of them settlement systems, i.e. the Central Bank’s real-time gross settlement system and the netting system operated by Fjölgreiðslumiðlun hf. Settlements of securities transactions are processed by the former system.
The main shock to financial stability and monetary policy would be if asset prices were to drop sharply at the same time as the growth of real disposable income slows down at the end of the aluminium-related investment boom. Lending developments As I mentioned before, lending growth is a cause for concern, both for financial stability and the Central Bank’s inflation target. Domestic lending grew at a brisk pace in 2003 and this development appears to be heading in the same direction this year. Total domestic lending by deposit money banks over the twelve months to the end of January increased by about 23%, which is above a rate consistent with longterm price stability and economic stability. The period 1998 to 2001 provides a recent example of the consequences of heavy credit growth. Both arrears and loan losses rose in the wake of the credit boom, leading to a temporary tightening of the commercial banks’ and savings banks’ foreign funding. While the recession and the ensuing strain on the financial system are now over, it can be partly ascribed to relatively favourable economic conditions and the consequently sharp turnaround in the exchange rate of the króna that financial companies only sustained minor setbacks. Proportionally, the highest growth in deposit money banks’ lending has been to foreign borrowers, but foreign currency-denominated lending to domestic entities has also surged, by more than 45% over the past 12 months.