In particular, there are policy decisions required in the following dimensions: (i)  eligibility (what collateral should be accepted, and what should not);  (ii)  valuations and haircuts (how much is the collateral worth? );  (iii)  what fees should apply, if any, and  (iv)  limits (how much diversification should we seek across the collateral delivered?). These are important questions for the banking system as a whole, and have presented new and complex risk management challenges for central banks over the past few years. It is on these issues that we focus in this paper.3 To start with, we briefly outline some of the main features of the Bank’s lending operations. The sterling monetary framework The Bank’s main activity in the sterling market prior to the financial crisis was via its shortterm repo open market operations (STR OMOs). Those regular weekly operations provided the banking system with the right level of reserves such that short-term market interest rates would remain close to Bank Rate set by the MPC.4 In addition, in order to reduce the size of weekly STR OMOs to a manageable size, the Bank undertook longer-term repo OMOs (LTR OMOs) of 3, 6, 9 and 12 months maturity. The remaining operation of note was the Standing Facilities in which a commercial bank could borrow from, or lend to the Bank overnight, albeit at a less attractive rate than Bank Rate.
Clarity is also needed concerning liquidity commitments to off-balance sheet vehicles, and the magnitude of assets that may be  BIS Review 3/2008  3  re-intermediated back onto the balance sheets of euro area financial institutions. The process of improving clarity, which started when Q3 2007 financial statements became available, will be advanced further when institutions publish their annual audited accounts for 2007 as a whole. Given the uncertainties, the adjustment process in the financial system in the coming period may be challenging, and we have to be prepared to the materialisation of risks at any time. That being said, there are mitigating factors, including a broadly favourable economic outlook, the largely sound balance sheets of households and firms, and the generally sound capital positions of core financial firms. This should not, however, provide any grounds for complacency given the heightened uncertainties. In a fluid environment where financial system conditions may unexpectedly change, prudence is of the essence both for policymakers and financial institutions. Concerning the role of financial institutions and supervisory authorities in coping with the financial turmoil, I would submit three observations. First, given the underlying factors of the financial stress, and in order to re-establish confidence within the financial system, it is crucial to promote a widespread consistent valuation of complex structured products as well as an adequate disclosure by banks of all their exposures, in particular related to the US subprime mortgage sector.