In terms of improved systems to enhance risk management internationally, the Continuous Linked Settlement Bank (CLS) was successfully established last autumn. It was an international response to a well recognised but partly unresolved risk: risk to foreign exchange settlement which goes back to the Herstatt crisis in 1974. CLS now settles FX transactions in eleven major currencies. And total daily values of transactions settled now exceed $ trillion: a figure that is likely to grow further. 2  BIS Review 49/2003  These are examples of ex-ante steps to reduce both the emergence of threats and their potential impact. But the third leg of our work is to consider what to do if there is a problem. What happens if a threat materialises? Firstly there is what I might call a “traditional” financial crisis involving one or more banks directly. All such crises ultimately manifest themselves in a shortage of liquidity, which can easily spill over from one bank to another. Clearly we need the market intelligence, expertise and operational experience to handle the liquidity aspects of such an event. Secondly, there is the possibility of what I would call an LTCM type problem. In autumn 1998 the creditors of LTCM - mainly banks and investment banks - became concerned by LTCM’s financial position. The concern was partly that even though LTCM may have been short of bankruptcy, there could be attempts by its creditors to reduce their exposures, and thereby to set off major market disturbances.
Others are more of a surprise, such as LTCM. What is certain is that financial crises can be very costly. For sovereign debt crises they can run to a loss of 15-25% of GDP. For Chile in the early 1980’s they were closer to 40%. So the art of minimising the emergence of crises, and mitigating their effects when they do nevertheless occur, are matters of public importance. For us in London the challenge is particularly real. Our focus must clearly be on the stability of the UK financial system. But markets have globalised; and they have also become more complex. With London a pre-eminent international financial centre, contagion from just about any significant financial crisis anywhere in the world has the potential to threaten financial stability here. In a broad sense, I like to think of financial stability in terms of maintaining confidence in the financial system. Threats to that stability can come from shocks of one sort or another. These can spread through contagion, so that liquidity or the honouring of contracts become questioned. And symptoms of financial instability can include volatile and unpredictable changes in prices. Preventing this from happening is the real challenge. So how do we fulfil our responsibility for the “overall stability of the financial system as a whole”? The Bank’s role is set out in the MoU. How do we approach the tasks of reducing the threat of crises and of coping with them if they actually occur?