However, a bank that does not use a realistic measurement of potential future exposure to decide how much collateral to require can later find its collateral holdings to be grossly insufficient. We expect the industry to develop more effective ways to measure and manage potential future exposure, and supervisors will closely monitor progress to ensure that this occurs. Stress Testing The Committee’s report also shows that banks must develop measures that better account for credit risk under extreme market conditions. This can be achieved through what we call “stress tests”, where a bank conducts “what if” analyses of how credit exposures to a single counterparty could grow under these market conditions. These might include a large rise or fall in interest rates or a major change in an exchange rate. More rigorous stress testing could have given banks at least some warning of the types of exposures they faced last fall. The critical importance of stress testing is noted very explicitly in our new supervisory guidance. Sound Practice Recommendations in the Basle Committee Report The Basle report is accompanied by a sound practices document that sets forth an important set of standards that will guide both banks and their supervisors.
There are studies indicating that domestic cost components may comprise as much as 75 per cent of the end-price.2 Arguing that the Riksbank cannot affect imported inflation is therefore simplifying rather too much. On the other hand, it may be the case that during the prevailing changeover process it may be quite reasonable to allow inflation to be below (or in a different situation, above) the inflation target for a period of time. This lies within the boundaries of the flexible inflation targeting the Riksbank conducts. A policy of flexible inflation targeting means that we always consider how large a deviation from the inflation target might be acceptable, and whether we can allow a little more time before bringing inflation back in line with the target. Another challenge is the low interest rates. At present, the Riksbank’s key rate is at an historically low level, although we are in the upturn phase of the economic cycle, at least this appears to be the case in our view of recent growth and our forecast for future growth. At the same time, one cannot rule out the possibility that inflation might remain low for a long period of time. If economic activity should  2  Burstein, Ariel, Martin Eichenbaum, and Sergio Rebelo (2005), "Large Devaluations and the Real Exchange Rate", Journal of Political Economy, Vol. 113, No. 4, August 2005, pp. 742-784. 6/7  decline substantially, the problem will be that there is little scope for further stimulation using monetary policy.