Increasing capital is one way to get leverage down; that is why governments in the US and other affected countries forced banks to raise more capital privately or else  12  BIS Review 101/2009  accept injections of extra capital financed by the taxpayer. Extending guarantees on funding, whether retail or wholesale, is another way to make creditors believe that they will get their money back, as are measures to insure or quarantine the risky bad assets. An open question is therefore whether the banking system will be able to support an adequate volume of credit as the extensive network of public support is removed. If not, then further attempts to de-leverage are possible. And de-leveraging through the restriction of new loans generates a positive feedback loop analogous to that through asset sales. Deleveraging by restricting credit growth may be privately rational, but if every intermediary tries to do the same, the result will be lower activity and higher defaults and little improvement in leverage ratios – what, to paraphrase Keynes, we might describe as the “paradox of deleveraging”. A recent insightful contribution from Gertler and Karadi (2009) explicitly captures the role that de-leveraging can play in slowing a recovery when financial intermediaries need to hold capital in order to convince creditors that they will be repaid. Policy: cure and prevention The severity of the financial crisis and the sharpness of the contraction in activity have prompted an aggressive response by policy makers.
While as a general rule I am against this invasion of jargon, perhaps in this specific case the initials are preferable to the longer version, because IPSs, the focus of this conference, are not merely “institutional protection schemes”, or legal instruments suitable for securing the benefits of consolidation under capital regulations. They are and should be much more than that. IPSs have arisen as an innovative structure in the banking system and, like all new products, they are best evaluated by organising their assessment in steps, or successive degrees of scrutiny, so that at the end of the process their structure can be fully appreciated. The first step in the process of evaluation will be to judge whether they are timely. The second will focus on their design and construction. The third will be a “use test”. And the fourth and final level of assessment will look at how readily they lend themselves to progressive development so as to cover potential future needs. Allow me to cover these successive steps or facets one by one. Let us start with the first, their timeliness. IPSs are a response to an unquestionable substantive need: the downsizing of the Spanish banking sector, following the excesses of the growth period prior to 2007. These factors left many institutions facing the challenge of a future far removed from the comforts that had characterised the previous period, namely: strong economic growth, abundant liquidity on international markets, extensive business margins and healthy assets.