Banks are also giving greater thought to the impact of an extreme event on the value of collateral and the proportion of that value that can be borrowed, as well as the sale value of any assets that they might consider liquidating. The assumptions here might prove to be optimistic particularly in circumstances such as those seen in 1998, when extreme events led to one-way markets and a vicious circle in which asset price falls did not lead to increased demand but rather to further increases in supply. It is for reasons such as these that the contingency planning that firms put in place needs to be sufficient. Banks have also placed increased emphasis on identifying potential sources of liquidity shocks. Products which entail the posting of margin, such as derivatives, can result in significant calls on liquidity. 4. Policy responses  So what gaps does this leave, and what policy responses are therefore needed on top of firms’ own actions? There is scope for further work by the private sector on improving liquidity risk management. But there are also a number of issues for public authorities to address. The preparations that firms make are influenced by regulation. When balancing the costs and benefits of measures to mitigate risk, banks naturally have regard to the interests of their own shareholders.
The European Central Bank’s proposed ‘Single List’ will also include certain bank loans; indeed these are already eligible in some member countries. Similarly, the Fed has broadened the range of collateral accepted at the Discount Window. A working group commissioned by the Basel-based CPSS (Committee on Payment and Settlement Systems) in 2004 has examined whether existing arrangements would prove adequate in an emergency. It would appear that some of the infrastructure required to facilitate more extensive crossborder use of collateral is already in place: links between securities settlement systems, for example. Nevertheless, central banks may need to put in place more cooperative and coordinated policies, such as the establishment of a framework for information-sharing. When risks do crystallise it is imperative that central banks, along with regulators and ministries of finance, are well prepared so that they are able to respond in an effective manner. The CPSS working group looked at preparations that are needed in order to be able to make effective use of existing infrastructure in a crisis. But it is equally important that central banks and regulators be in a position to make the decisions necessary for resolution of a crisis, both individually and, when needed, collectively. This entails gathering data and intelligence on firms and markets, sharing it appropriately amongst all relevant public authorities, understanding the systemic conjuncture, and setting up national and international frameworks for coordination of decision making. I could give an entire speech about questions in these areas, and current and potential initiatives to address them1.