27.08.2012

Prudential rules after capital controls

The Central Bank has published on its website (in Icelandic - English version available soon) a Special Publication entitled Prudential rules after capital controls: the Central Bank’s report to the Minister of Economic Affairs. In the Capital Account Liberalisation Strategy published on 25 March 2011, it was stated that before the capital controls would be lifted vis-à-vis Icelandic residents, it would be necessary to set prudential rules designed to protect the financial system against the risk that could accompany unrestricted capital flows, including liquidity risk in the financial institutions’ foreign-denominated balance sheets and risk entailed in foreign-denominated lending to residents without income or underlying assets in the borrowed currencies.

In the report published today, there is also a discussion of the possibility of placing temporary restrictions on the pace at which pension funds may build up foreign assets after the controls have been lifted. The report also discusses possible rules or policy instruments that could be used in response to excess capital inflows of the type that occurred in Iceland during the run-up to the financial crisis.

After the report is published, the pertinent ministries, the Central Bank, and the Financial Supervisory Authority will begin to formulate such rules in their final form, including proposing legislative amendments where appropriate. The first part of the report describes this work in greater detail.

Cross-border movement of capital generally enhances value creation and welfare, but it can also entail risk. These prudential rules discussed in the report should limit foreign exchange risk in the financial system, as well as limiting foreign currency liquidity risk; furthermore, they will, in combination, limit the banks’ potential for excessive growth. It can be argued that, had they been in effect before the collapse, the impact of the global financial crisis on the Icelandic financial system would have been less pronounced.

The report, Central Bank of Iceland Special Report no. 6: Prudential rules after capital controls: the Central Bank’s report to the Minister of Economic Affairs, can be found in Icelandic (English version available soon) on the Central Bank of Iceland website: www.sedlabanki.is

Further information can be obtained from Már Guðmundsson, Governor of the Central Bank of Iceland, at tel: +354 569-9600.

View the report here (available in English soon):
Special Report no. 6: Prudential rules after capital controls: the Central Bank’s report to the Minister of Economic Affairs 

The Icelandic version: Sérrit nr. 6; Varúðarreglur eftir fjármagnshöft; Skýrsla Seðlabanka Íslands til efnahags- og viðskiptaráðherra (PDF).
 

 
No. 31/2012
27 August 2012 

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