This problem of socially excessive risk-taking is particularly damaging in the case of large interconnected institutions whose failure would endanger other institutions, with adverse consequences for the broader economy. Finally, the issue is further exacerbated if an implicit or explicit guarantee of state support is extended to such institutions. The chain of distorted incentives which has just been described, and, in particular, the moral hazard issue implied by the guarantee of state support, is now well recognised and is being addressed energetically by the various regulators.3 The second source of systemic risk has a cyclical dimension (slide 2). This is the aspect on which I would like to focus today. Here, systemic risk arises from the procyclicality of financial agents’ behaviour, leading to the amplification of financial cycles.4 Procyclicality can arise, for instance, from the tendency to underprice risk during booms and to overprice it in downswings. Sometimes exacerbated by regulatory requirements, it causes agents to take similar actions in case of an adverse shock, namely to dispose of risky assets when prices fall. While this behaviour may be individually rational, the outcome can be socially devastating. Indeed this collective reaction tends to amplify an initial price movement, thus leading to another round of asset selling, in particular if the boom is mainly financed through credit. A financial system facing such strains is forced to retrench further from risk-taking and eventually from credit intermediation, leading – in extreme cases – to an outright credit crunch.

The most important concern in this regard is that, if the CCB generates capital constraints at some banks, these banks will need to decide which sector to keep lending to. It may seem reasonable that institutions will prefer to keep lending to the booming sector, while cutting back on lending to other sectors. The design of the CCB takes such undesired side-effects into account. In particular, the sectoral approach alleviates this problem to some extent. By increasing the cost of granting credit to a given sector (real estate lending) relative to others, it should discourage lending to the former as it is “penalised” in terms of higher capital requirements. And, thanks to its dynamic nature, the CCB can be flexibly adjusted, should it still have undesired consequences in other segments of the credit market. Conclusion To sum up, the global crisis has clearly stressed the need for a more comprehensive approach to financial stability. The potential cost of a systemic crisis is significant. Remaining idle is no alternative. We must insist on addressing systemic risk issues head-on. This is the intent of macroprudential instruments. In Switzerland, financial stability risk is currently building up, driven by persistently strong momentum in the mortgage and real estate markets. Against this background, the availability of a tool such as the CCB is a significant step forward. The CCB is a “soft”, incentive-oriented instrument based on the principle of prudence. It can and will be used in a balanced and flexible way to deal with specific cyclical risks to financial stability.