when the interests of the institutions and the markets do not coincide with the interests of society as a whole - the lenders’ short-term market-share philosophy at the end of the 1980s is an example of this. If means of control are needed, they should be designed as far as possible to lead to solutions that are compatible with the normal working of the institutions and markets. Some problems We can all see that interest in risk management has increased and that considerable resources are being invested here. The interest applies to both the production of new financial instruments, the emergence of new markets and the practical measuring and management of various risks. In addition, awareness is being stretched to cover new types of risk that did not previously receive the attention they deserved, such as operational risks, interest risks throughout the bank, liquidity risks and legal risks. This is essentially a positive development, but let me nevertheless conclude by pointing out  BIS Review 10/2004  3  some phenomena and situations, which indicate that the new developments have also brought about problems that need to be discussed and hopefully solved. The best known example is perhaps the LTCM debacle. The hedge fund suffered a sudden decline in value, which led to a confidence crisis among customers and it had to be shored up with liquidity infusions of many billions of dollars from a group of banks.
BIS Review 10/2004  1  The authorities responsible for the institutions and for financial stability, mainly Finansinspektionen (the Swedish Financial Supervisory Authority) and the Riksbank, had not built up sufficient competence regarding the financial risks. Nor did the legislation suffice as a basis for the authorities to limit imprudent credit-granting. The oversight of the banks and other credit-granting bodies therefore became formalistic and fragmentary. We were not always looking in the right places. In defence of the banks’ management and the authorities it can be pointed out that risk assessment was made difficult for many different reasons. Several important factors counteracted a sound financial development, such as the high inflation rate, misleading tax incentives and central government subsidies. In addition, there was a lock-in effect in that currency regulation, which was in force until 1989, had kept our capital inside Sweden and contributed to a form of hothouse effect. The banks did not take these factors into account in their risk assessment, or not to a sufficient degree. They then suffered the consequences when the government made some decisions that were desirable in themselves, but which altered conditions drastically. Inflation was pushed down, the tax system was reformed and subsidies were erased. Developments in the property market were a central component in the banking crisis, as the banks’ credit-granting meant they were highly exposed to the property sector. Property prices rose at an unreasonable rate, regardless of how one measures them. They left the basis for normal pricing, i.e.