Macro-prudential policy needs to be operational soon, but some difficult hurdles remain to be overcome. 2  BIS central bankers’ speeches  An important challenge for the design of a new regulatory framework will lie in finding an appropriate balance: on the one hand, the regulations will need to be sufficient to effectively reduce the risk of financial crisis; on the other hand they should not be so stringent as to impose unnecessary costs on the financial sector. It is a matter of finding just the right level of regulation. Handling the interactions between monetary policy and macro-prudential policy poses further challenges. During the recent financial crisis, we observed the difficulties of conducting monetary policy in a non-stable financial environment. Interest rate signals from the central banks were sometimes dwarfed by contradictory events in the markets. Conversely, financial stability is dependent on smooth and predictable monetary policy. Thus, policy makers must always keep in mind that the increased use of regulatory tools will inevitably affect monetary policy in different ways. Regulations will affect the interest rates that firms and households meet and this is something that the central bank needs to take into consideration when setting the policy rate – in much the same way as monetary policy has to take into account changes in interest-rate spreads due to changes in financial conditions. A key element in handling the interactions between monetary policy and macro-prudential policy will be putting an appropriate governance structure in place.
•  Thirdly there are a number of different potential policy instruments that can affect the financial environment in various, sometimes conflicting, ways. And by no means are all in the hands of central banks  •  Fourthly national financial stability responsibilities are often shared. In the UK we work with Her Majesty’s Treasury (HMT) and the Financial Services Authority (FSA). For cross-border activities we operate alongside overseas central banks and supervisors. •  Fifthly although the roles of the UK authorities are outlined and published in a Memorandum of Understanding (MoU), this gives little guidance as to what financial stability is or a clearly identifiable target. •  And lastly it is harder to get motivational feedback – unless in unwelcome form should a crisis occur. 3. Defining Our Role in Financial Stability Oversight  These factors pose a number of challenges in defining our role in financial stability oversight – what activities should we as a central bank undertake? To make these decisions, firstly we should identify the main functions that need to be performed in each jurisdiction to promote financial stability. Then we can look at the Bank’s own institutional mandate. And finally we can determine the most appropriate way to fulfil it. i)  The Three Essential Functions for Public Authorities  There seem to me to be three essential functions to be carried out in securing financial stability: I think this is the case in most jurisdictions.