To the extent that these markets and counterparties are important for the functioning of the financial system and for the real economy, problems transmitted can have adverse consequences for economic growth and financial stability. The market channel Let’s start with the market channel. Here excessive or poorly-managed leverage increases the potential for forced asset sales in the face of shocks, with adverse implications for market functioning and so the real economy. Feedback loops and amplification mechanisms can arise in two ways – through unexpected liquidity strains (most obviously as a result of margin increases) or through large, concentrated positions. I’ll cover liquidity strains first. Banks and CCPs typically require their counterparties to place collateral, in the form of margin or haircuts, to protect against counterparty risk. And sharp changes in asset prices, high volatility or correlated shocks affect the amount of counterparty risk to which they are exposed. As market prices change and as risk rises, the bank or CCP can request more collateral. (Variation margin to reflect the change in market prices; and higher initial margin to reflect greater risk in a given position.) And meeting those collateral demands creates liquidity risk for the leveraged institution that needs to be managed. This more widespread collateralisation of derivatives has been an essential part of the package of reforms to address fault-lines exposed in the Global Financial Crisis. Initial margin requirements are vital to limit cascading counterparty credit risks, as I will cover later.
Jaime Caruana: Consequences of Basel II for SMEs Address by Mr Jaime Caruana, Governor of the Bank of Spain and Chairman of the Basel Committee on Banking Supervision, to the European Parliament Workshop on the "Consequences of Basel II for SMEs", Brussels, 10 July 2003. *  *  *  Introduction Good afternoon. I would like to thank the European Parliament for organising this important workshop on the New Basel Accord and its implications for small- and medium-sized enterprises in Europe, and for inviting me to participate. I’m privileged to join you as the new chairman of the Basel Committee on Banking Supervision, and I welcome this opportunity to offer our views. As you know, the Basel Committee was founded almost thirty years ago to help promote safety and soundness in the banking sectors. We believe that, when banks are adequately capitalised and wellmanaged, they are better able to promote growth by providing credit to consumers and businesses alike. But more broadly, when banking systems worldwide are adequately capitalised and wellmanaged, the international financial system becomes more stable, better able to promote sustainable growth, and more resilient during periods of distress. Of course, simply providing credit does not guarantee growth. Indeed, how credit is applied matters greatly to the development of an economy. And in every economy, small businesses have long been the true engines of economic growth. Small and medium-sized enterprises traditionally produce much, or even most, of the technological innovations in business and industry.