However, the definition of this liquidity buffer, as well as what type of assets should be viewed as liquid, requires careful thought. We should keep in mind the lesson that market liquidity can vanish quickly and be extremely cautious about what securities we consider to be liquid. Furthermore, the power to dictate the type of assets a bank must hold will have an impact on asset markets. We must ensure that this power is not misused. From a central banker’s perspective, the content of the liquidity buffer has a bearing on the central bank’s policy on what assets to accept as collateral. In a crisis, it is the central bank’s  BIS Review 118/2009  3  decision on which securities to accept that defines liquid and illiquid assets – at least in the local currency. Therefore, the interplay of liquidity regulation and the central banks’ collateral requirements also warrants considerable reflection. Finally, liquidity regulation will make maturity transformation more costly. We clearly need more regulation today but, in casting additional regulation, we have to consider the costs. Too strict regulation would stifle competition, make financial services more expensive and, in the long run, hamper economic growth. On the other hand, too loose regulation would inspire speculation with taxpayers’ money and also reduce economic growth. Thus, the extent of financial regulation is – at least partly – a question of society’s risk tolerance. Liquidity buffers will create a cushion. However, the root of a liquidity crunch is a lack of confidence.

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