This is relevant to how banks themselves might estimate risk to their asset portfolios through their internal  16  The definitions of these variables are as follows: capital is the risk-based Tier 1 ratio; asset quality is proxied by loans past due as a per cent of total loans; management is proxied by the cost to income ratio, with lower values pointing to greater efficiency and, in principle, better managerial quality; earnings is measured by the return on assets; and liquidity is defined as US government bonds, cash and deposits with banks as a per cent of total assets. 17  Specifically, from the overall sample of about 8,500 banks, we pick random sub-samples of 100, 250, 500, 1,000 and 4,279 observations. We estimate the models using the smaller sub-samples and use the parameters to predict failure out-of-sample for the remaining 4,279 observations in the dataset. To minimise the risk that our results are distorted by the specific choice of sub-sample, we repeat this exercise 10,000 times. So, for example, we end up looking at the out-of-sample performance of 10,000 estimated models using samples of 100 observations. Throughout, we reject sub-samples if there are no observations of bank failures. 12  BIS central bankers’ speeches  models. It enables us to ask what size of time-series sample is needed before less-is-more effects dissipate. It also enables us to assess the effects of expanding the range of assets on the choice of simple versus complex rules.
Wide-ranging cuts have been announced in the affected countries, and international rescue packages have been put together, first for Greece and latterly also for Ireland, in order to prevent the situation from escalating. The markets will, however, be monitoring the effectiveness of the announced cuts and support measures very closely. The problem of sovereign indebtedness in Europe remains a source of considerable uncertainty. A high level of uncertainty also remains on the foreign exchange markets. The continuing high volatility is coupled with strongly divergent exchange rate developments. Over the last few years, a number of currencies have appreciated substantially against the two major world currencies: the euro and the US dollar (cf. chart 1). These currency shifts do not just negatively affect the export capability of the countries whose currencies have appreciated; they also have a heavy impact in monetary terms. This is because, in order to keep appreciation in check, some countries have intervened in the foreign exchange markets, with some others even resorting to restrictions on the movement of capital flows. The result has been a global rise in foreign exchange reserves. Indeed, they have almost doubled in the past four years (cf. chart 2). The high level of foreign exchange reserves ultimately reflects substantial global economic imbalances. As we know, the Swiss franc also appreciated substantially in the wake of the financial crisis. Looking at how the Swiss franc’s real and trade-weighted external value has changed over the long term (cf.