It is perhaps inevitable that as time passes and memories fade, there is less political focus on these issues and less will among jurisdictions to ensure governance keeps pace with the risks. Fatigue sets in. For example:   Before the crisis Basel II, which was not particularly ambitious, took 10 years to agree.   By contrast, post-crisis the key elements of Basel III, which was a significant step-change, took just 2 years.   But as the crisis receded and fatigue developed, it took a further 5 years to finalise Basel 3.1, which implemented less sweeping changes. The lesson fades that in an integrated global economy we are all ultimately in the same boat or in the words of Benjamin Franklin that “if we do not hang together we will most assuredly hang separately”. This had led to fragmentation in the way we implement the reforms we have agreed. Moreover, the circle of players has grown. The governance reform efforts of the last 50 years have been predominantly led by the advanced economies whose financial institutions dominated the global economy. That is changing with the increasing importance in the global economy of emerging markets – indeed much of the financial innovation we see today is happening in the emerging market and developing world rather than in the advanced economies. We are now in short having to work harder to generate the consensus to keep the governance necessary for financial globalisation moving forward in line with the risk. And we can see major challenges emerging.
To sum up, the extent to which the central bank uses collateralised lending to intermediate between banks has proved helpful in restoring confidence and “real money” financial flows in the underlying asset markets – the markets in which the collateral is priced. This has repaired links in the early stages of the transmission channel, the viability of which depends on those collateral prices. These links would have been brutally and perhaps irrevocably severed, if private arbitrage had been the only force of market motion, as in normal times. But increased intermediation has an impact on the liquidity risk exposure of banks, on their ability to carry out maturity transformation, as well as on the liquidity of specific money market segments. Whether the impact is positive or negative is hard to say. But moral hazard – which is the pitfall of any such type of thinking – makes conditions (and behaviours)  2  The significant increase in activity in the primary market for covered bonds – which the ECB started purchasing in July 2009 in the context of the covered bond purchase programme – is an example of how these measures have stabilised financial markets. 4  BIS Review 83/2010  change in response to central bank actions. As was the case at the start of the rational expectations revolution in macroeconomics, a prudent central bank needs to internalise the private sector’s response to its own actions. 4.