And it failed to recognise that central banks have a vital role to play in maintaining financial stability because of the deep underlying connection between it and monetary stability. Both are fundamentally about maintaining the public trust and confidence in money and financial intermediation that are essential for them to oil the wheels of commerce. That trust and confidence can be undermined through a loss of certainty about the future value of money, a loss of confidence in financial intermediaries, or ultimately a loss of faith in the financial system. Central banks have a primordial responsibility to act as guarantors of trust and confidence in money because of their status as monopoly issuers of currency. This naturally gives them control over the quantity of money and interest rates – monetary policy. It also means that a core part of financial stability policy – acting as lender of last resort to private financial institutions at times of financial stress – falls naturally to central banks. Other instruments of financial stability policy seek to prevent the build-up of vulnerabilities in the first place. Microprudential supervision aims to maintain the safety and soundness of individual financial institutions by ensuring they are adequately capitalised and have sufficiently resilient funding and liquidity. Macroprudential policy seeks to safeguard the stability and resilience of the financial system as a whole both by using prudential policy for macroeconomic ends – for example in managing the financial cycle – and by addressing risks related to structural features of financial institutions and markets.

But overly permissive terms create a moral hazard risk in the form of banks running excessive liquidity mismatches in normal times.16 Prudential supervisors can mitigate the moral hazard risk by imposing minimum liquidity requirements. But there is no point in setting those requirements at a very high level when the central bank is prepared to lend freely against good collateral to solvent institutions. So it is important to coordinate liquidity requirements and banks’ reliance on liquidity insurance from the Bank of England. Striking an efficient balance is most likely when responsibility for prudential policy also lies with the central bank.17 And it explains why we are announcing management changes today to enhance that coordination, with Paul Fisher – the Bank’s Executive Director for Markets – moving to become Deputy Head of the PRA. The Bank exploited those synergies in August 2013 when, recognising the greater availability of liquidity insurance provided through our facilities, and banks’ improved capitalisation, we reduced the required level of banks’ liquid asset holdings to help support lending to the real economy. And in October last year we overhauled our facilities, offering money and collateral for longer terms against a wider range of assets, at lower cost. We could do so because, as both supervisor and provider of liquidity insurance, we can manage any resulting moral hazard risk.18 More importantly these changes recognise and support the evolution of markets and the growing importance of collateral that in turn stems from financial reform.