Let me give you just two examples. First, different liquidity categories were introduced in February 2004 to better mirror the risks associated with different asset classes. More liquid central government debt instruments are in category 1, while less liquid asset-backed securities are in category 4 to reflect the limited secondary market liquidity of those instruments. The second example is the establishment of the previously mentioned specific eligibility criteria regarding asset-backed securities, which were inter alia introduced in 2006 to exclude instruments such as synthetic CDOs and cash CDOs containing other synthetic tranches of ABSs. Due to the opaqueness of the market and the product complexity, those instruments were not deemed suitable as collateral for central bank credit operations. The current developments confirm the appropriateness of the measure. The currently ongoing market turmoil has presented us with a wealth of information both on how our collateral framework interacts with financial markets and financial market participants and on the appropriateness of our risk control framework. We will continue to  6  BIS Review 68/2008  assess carefully the collateral we receive and make sure that the rules outlined in the collateral framework are strictly applied, as well as to study whether there are elements in our collateral framework that may need to be refined to make it even more effective. 6. Going forward: transparency  The recent events have highlighted a number of weaknesses in the financial system, namely in the areas of transparency, valuation, risk management practices, the current prudential framework and market functioning.

In particular, thanks to the built in flexibility of its collateral framework, the Eurosystem has been able to step in effectively when intermediation in interbank markets deteriorated, without the need to make changes to its framework. As a side effect of the broad range of assets accepted as collateral, the framework helped us also during the turmoil to address liquidity squeezes in some markets, including the ABS market, as it mitigated refinancing risks for asset classes that had become illiquid. This has contributed to financial stability in the euro area. Other central banks may have had those effects in mind when they initiated changes to their operational framework in the wake of the turmoil, leading to a significant degree of convergence among the various frameworks. Of course, the ability of the Eurosystem’s operational framework to respond to the challenges for monetary policy implementation posed by the recent period of financial market volatility does not mean that there is no scope for further improvements and refinements. For instance, the eligibility criteria for marketable debt instruments have been kept general in order to ensure that the collateral framework of the Eurosystem is responsive to financial innovation. There is therefore a concomitant need for the Eurosystem to refine its collateral policy, including the risk control measures, and ensure that the collateral continues to meet the Eurosystem’s risk tolerance level and allows the effective implementation of monetary policy. This has already been done in the past from time to time, with a view to further enhance the collateral framework.