Important public policy decisions are also involved in dealing with financial institutions which, for whatever reason, find themselves with an inadequate capital. Low levels of capital can lead to the phenomenon of “gambling for resurrection” – banks pursuing risky strategies in the knowledge that shareholders will get the benefit of good outcomes, while bad outcomes will impose losses on third parties.
Thus far, I have discussed financial stability in terms of the health of the institutions that go to make up the banking system. But there is another dimension that has received increasing attention from central bankers over the past 10-15 years. It concerns the market infrastructure that underpins financial transactions, and in particular the payment and settlement system.