Over the past seven months, this fact has been confirmed by the increasingly strong correlation of bank CDS with those of the country where they are located. It is an area of concerns for banks especially in the case of a rapid and abrupt evolution. A surge in the cost of funding will be therefore damaging for banks profitability and their ability to grant credits. Short-term funding may also cause some concerns for banks as multiple sovereign downgrades can lower, either through a decrease in market prices or through an increase in haircuts, the value of government securities used to collateralize refinancing. On the asset side, banks are exposed to an abrupt drop in sovereign debt prices through mark-to-market losses on sometimes large trading portfolios of government bonds detained as a liquidity buffer. In addition, banks active on CDS as net protection sellers are also exposed to mark-to-market losses and real losses in case of a debt restructuration which constitutes a credit event triggering the CDS. These losses could erode the capital base of the banks at a time when the risk weighting of assets, based on credit rating levels, increases. The two factors push down capital ratios and reduce the potential for lending to the economy. It brings us to our third contagion channel. 2  BIS Review 84/2010  3)  Lastly, the economic channel is likely to play a significant role via the fiscal adjustments necessary to repair public finances and restore the credibility of the countries on financial markets.
But I draw upon my own experience in the corporate world and upon the insights offered by Goodhart to suggest that you simply take all this forward guidance and forecasting a year or more out with a big grain of salt, bearing in mind that the policy statements and forecasts issued by the FOMC are tactical judgments of the moment, made within a broader strategic context. 6  “Longer-term Central Bank Forecasts Are Step Backwards,” by Charles Goodhart, Financial Times, Feb. 2, 2012. BIS central bankers’ speeches  5  The most important announcement Which leads me to what I consider the third and most important announcement we made last week: the statement of our longer-range goals and strategy. For the first time, the entire 17-member committee stated that, given inflation over the longer term is primarily determined by monetary policy, we are able to specify that an inflation rate of 2 percent, as measured by the index for personal consumption expenditures, is most consistent with our mandate.