The financial soundness of a central bank, the usual lender of last resort in a country, is an important firewall for trouble in the financial system. While a central bank may count with the help of the sovereign, this channel may be a source of concern when sovereign themselves are facing problems, and it also raises some worries about the ability of the central bank to maintain its independence. There are also those who argue that, since the liabilities of central banks can be arbitrarily created, the financial position of a central bank shouldn’t matter. But this argument forgets that doing so may endanger the achievement of the inflation targets that many central banks have taken as their operational goals, affecting their reputation and independence. 2  4  Céspedes et al. 2012. BIS central bankers’ speeches  In 1982, as the debt crisis spread through Latin America, the Chilean financial system, which had channeled substantial foreign-currency-denominated syndicated loans, became largely insolvent. Under these conditions, the government engineered a massive rescue operation through the central bank where several of the most important banks became nationalized and others disappeared, after their assets were absorbed by other institutions. This intervention prevented an even larger collapse of activity than the one we ended up experiencing. The manner in which it was implemented, where shareholder equity was fully diluted and institutions assumed a subordinated debt to the central bank that took a long time to repay, helped maintain the rescue’s moral hazard concerns at bay.

For instance, increases in reserve requirements affect only the banking sector, which may lead to disintermediation and increased cost of credit for those with limited access to other sources. In Chile many of these tools are under the control of the Superintendence of Banking and Financial Institutions (SBIF). This makes the Financial Stability Council I just mentioned a crucial instance for coordinating and implementing financial regulation with a systemic view. 3. Monetary policy in an environment of financial crisis  When using policy tools to prevent financial crisis is not enough and the financial system becomes unstable, standard monetary policy tools might be impaired. Many central banks target the overnight interbank rate, so the transmission of monetary policy relies on a working financial system and its effectiveness may be significantly weakened in conditions of financial distress. Furthermore, under extreme conditions, such as those experienced during the recent financial crisis, standard monetary policy may reach its natural limit that is the zerolower bound. Under these conditions, unconventional monetary policies may be the only ones at hand for a central bank. BIS central bankers’ speeches  3  The experience of the United States and Europe with unconventional tools during recent years is well known to all of you, so let me briefly describe our experience with them. It is important to mention that the scale of our interventions was substantially smaller, since we had to quickly undo many of our policy actions because of the fast recovery of the Chilean economy after the recession of 2009.