This is more likely when the underlying risks are themselves fat-tailed. While complex approaches can appear to perform better 19  For example, DeMiguel et al (2007) find that, for a sample threshold of N = 25, complex rules outperform simple ones only for sample sizes of in excess of 3000 months (250 years) of data. 20  All speeches are available online at www.bankofengland.co.uk/speeches  20  in-sample, simpler approaches may be more robust to out-of-sample structural shifts and fat tails, the like of which we have seen in past financial crises, from railways in the 19th century to subprime mortgages in the 21st. This problem is not unique to banks. Stress tests can reduce reliance on banks’ own models. But they then still rely on regulators’ risk models, which may be vulnerable to similar issues, especially if they are formulated in an excessively granular manner (Hale et al (2015)). Liquidity and Funding  Historically, most banks failures are precipitated by insufficient liquidity. Due to maturity transformation, banks are vulnerable to a sudden withdrawal of funding due to bank-specific or market-wide losses of credibility. In such circumstances, banks will be more robust if they have a buffer of high-quality liquid assets allowing them to meet outflows, survive the first stages of a bank run and, if necessary, giving the authorities time to prepare for resolution. The Basel III LCR was designed and calibrated with these considerations in mind. But excessive maturity transformation can also create risks over longer horizons.
This applies to the 1997 convergence criteria themselves, of course. It also applies to performance against those criteria in later years. And, in our view, perhaps more controversially, it applies to other aspects of the real economies of applicant countries, particularly to the structures of their labour markets. In the case of the convergence criteria, our attitude is straightforward. They must be rigorously respected. And that applies to the substance, as well as the form. So it would be unwise for a country to seek to qualify in 1998 by massaging down its 1997 public sector deficit through artificial, unrepeatable devices, even if those devices are not technically disallowed. It would be unwise, because the deficit limit is not a one-off requirement. Continued discipline on individual member states’ budget positions is a crucial element of EMU in the future. Friday’s agreement at Dublin provides for such discipline, albeit with an element of political judgement over the way that discipline will be exercised in certain circumstances. But the general conclusion is clear. Member states will need to live with continued fiscal discipline. In our view, unless a country can show that its fiscal position is structurally sound - in other words that in mid-cycle, with the economy growing at trend on its potential growth path, the budget of the government would tend to be close to balance - then it may find the fiscal discipline of EMU difficult to sustain. That is both a long-term point, and one relevant to the transition period.