The existing size of the sterling T-bill and gilt repo markets may, however, limit the extent to which this solution would be achievable in sufficient scale to meet the needs of sterling investors, at least in the near term. And this would of course also have significant implications for the funding of banks. Second, at the other extreme, the liquidity mismatch could be removed by making funds nondaily dealing – i.e. not cash on demand. This would require a term notice period. Such a fund would be somewhat like a term deposit with no break clause. This would fundamentally change the potential uses for which MMFs could be held, and so would also have repercussions for the demand for other instruments, such as bank deposits, the implications of which would require further consideration. Third, there may be a middle option whereby a combination of measures are used to reduce the risks to a sufficiently low level. We have a menu of options to choose from. For instance, a limit could be introduced on the percentage of assets a money market fund could hold in nongovernment instruments, to reduce the holding of less liquid assets. This could be combined with making sure funds are structured as variable net asset value, albeit with this asset mix the variability of the value in the fund should be lessened. And we would need to ensure the absence of regulatory cliff-edges, so that funds could be more confident to release their cash buffers in times of stress to meet withdrawals.
At the Bank of England we do still consider that the stability of the financial system depends crucially on the stability of the banking system. Banks are at the heart of the payments system, they are the principal source of funds for many businesses, and they are an important savings medium for a large part of the population. The regulatory framework in turn affects the behaviour of banks, making it essential to get it right. It needs to create both the right incentives, and establish the right level of buffer - in the form of capital - to protect the system. We fully support the Basel Committee’s objective of updating the 1988 Accord to make it more comprehensive and risk sensitive. And as a member of the Basel Committee, the Bank is working alongside the FSA to ensure that these objectives are delivered. Importance of risk sensitive capital charges I am aware that some commentators have questioned the aim of making the system reflect risk in a more differentiated way. One argument is that this will make capital charges procyclical, so that economic downturns or external shocks are amplified by the regulatory demand for higher capital. There is a concern that the consequences could be particularly severe in the case of lending to emerging markets, where rating changes have sometimes lagged the onset of crises. This is certainly a risk, and one which we have to take seriously. Clearly there could be macroeconomic implications, both domestically and internationally, possibly on a systemic scale.