), 2003: “Monetary policy transmission in the euro area”, Cambridge University Press. 3  Kashyap, A. and J. Stein (2000): “What do a million observations on banks say about the transmission of monetary policy?”, American Economic Review 90(3) , pp. 407-28. 4  European Securitisation Forum (2008): “ESF securitisation data report – Q2:2008”. 5  European Central Bank (2008b): “The role of banks in the monetary transmission mechanism”, ECB Monthly Bulletin, August 2008, pp. 85-98. 6  See, for instance, Altunbas, Y., L. Gambacorta and D. Marquéz (2007): “Securitisation and the bank lending channel”, ECB Working Paper No. 838, and ECB (2008a). 7  See, for instance, Gropp, R., C. Kok Sørensen and J. Lichtenberger (2007): “The dynamics of bank spreads and financial structure”, ECB Working Paper No. 714. 8  European Central Bank (2008c): “The euro area bank lending survey”, January 2008. BIS Review 116/2008  3  4. The role of uncertainty  One of the most relevant features of the current turmoil has been the high degree of asymmetric information and the enormous increase in general uncertainty in the financial sector. I would like to distinguish between the two in the following way: 9 Uncertainty owes mainly to imperfect information in relation to credit valuations. Uncertainty generally increased during the summer of 2007, because market participants realised that the current practices used for valuations – often based almost solely on ratings – were no longer valid. With this type of uncertainty, market participants have difficulty in modelling the expected occurrence of defaults.

This principle relates to the dichotomy between the ECB’s monetary policy and its liquidity policy or, in other words, between the formulation and implementation of monetary policy. During the turmoil, the separation principle proved to be very effective. Supported by the flexibility of its operational framework, the ECB was able to react in a flexible and quick manner to a changing market environment, and it allowed the steering of interest rates close to the policy rate by means of temporary quantity adjustments, albeit without increasing the aggregate supply of euro liquidity to the banking sector. The main objective of the ECB’s immediate and lasting responses to tensions in the money market was to keep under to control the very short-term interest rates as the first step in the transmission of monetary policy. Broadly speaking, the ECB’s liquidity policy response consisted of three elements: First, it changed the timing of the liquidity provision within the maintenance period (the so-called “front-loading policy”), and thereby allowed banks to build up temporary liquidity buffers. Second, it lengthened the average maturity of its tender operations: before the turmoil, the bulk of liquidity was supplied through one-week operations, and only about 30% was auctioned for three months. As the turmoil unfolded, the ECB gradually increased the share of the three-month operations and moreover introduced a six-month maturity operation. Finally, it participated in the joint coordination effort of an increasing number of central banks around the world within the context of the Term Auction Facility.