It has revealed the fallout from the failure of large financial institutions. It has revealed the fragility of the financial system to features and trends that cut across institutions, markets and infrastructures. And it has illustrated the amplitude of the consequences of the adverse feedback loop between the financial system and the real economy. All these three elements are key features of systemic risk: first, contagion; second, the buildup of financial imbalances and unsustainable trends within and across the financial system; and third, the close links with the real economy and the potential for strong feedback effects. The crisis has revealed the fundamental importance of systemic risk. Of the three elements I have mentioned, contagion and the link to the real economy are the least novel in the current episode. The most unexpected element has been the rigour with which systemic risk has been triggered by the collective behaviour of financial institutions and the ways in which they interact in financial markets. The main new avenue to explore is therefore to improve our understanding of interconnectedness in the financial system, both via the direct links between financial institutions and the indirect ones created in financial markets. Everybody now sees that major risks can emerge from within the financial system itself. It was not the real economy that threw the financial system into disarray, but the reverse. BIS central bankers’ speeches  3  Endogenous risks – risks that emerge from within the financial sector – can have many causes.

Finally, authorities will need new regulatory instruments to keep pace with the impact of new technologies – including high frequency trading, algorithmic trading and the new universal trading platforms, which are gaining ground very rapidly. Last week, the ESRB selected the members of its Advisory Scientific Committee to provide advice on analytical issues. We have also established the Advisory Technical Committee, which assembles experts from all central banks. The institutional set-up is completed and the ESRB will now focus on its substantive tasks, of which we will have a substantive review in June this year. Combining a focus on short-term risks with the medium- and longer-term perspective will be the major challenge. Conclusion Let me conclude. I believe we are now about halfway through the comprehensive reforms that the crisis has called for. We have achieved a blueprint of more stringent bank regulations that includes more loss-absorbing capital, better risk coverage and limitations for undue leverage. Countercyclical capital buffers are meant to lower pro-cyclicality. The oversight of financial institutions as well as markets and market infrastructure are being strengthened, and the organisational structure of financial supervision is being overhauled. But much remains to be done. The most important aspect is the implementation of these reforms. Moreover, the issue of systemically important financial institutions requires further reflection, and oversight of the proper functioning of financial markets in a way that avoids undue volatility, excessive influence of dominant players and oligopolistic market structures, while reinforcing transparency, needs to be addressed resolutely.