Philipp Hildebrand: Monetary policy and financial markets Speech by Mr Philipp Hildebrand, Member of the Governing Board of the Swiss National Bank, at the Schweizerische Gesellschaft für Finanzmarktforschung, Zurich, 7 April 2006. References to the speech can be found on the Swiss National Bank’s website. *  *  *  Introduction Today marks the twentieth anniversary of the Swiss Society for Financial Market Research. I am honored to be able to address you on this occasion. As a central banker and as a former market participant, it is a special privilege to talk to you about how monetary policy and financial markets relate to each other. But before I begin, let me extend my congratulations and best wishes. I trust that the efforts of the society will continue to foster our understanding of financial markets for many years to come. Monetary policy and financial markets are intrinsically linked. Central banks conduct monetary policy by directly and indirectly influencing financial market prices. Since financial market participants seek to extract profits from buying and selling securities, markets inevitably pay close attention to both words and deeds of central banks. The relationship between monetary policy and financial markets is by no means a one way street, however. Financial market prices reflect the expectations of market participants about future economic and monetary developments. These expectations, in turn, provide valuable information for central banks in determining the optimal future course of monetary policy. In today’s remarks, I will begin by discussing how monetary policy influences various financial market prices.

The causes and consequences of the recent Asian financial crises are still vivid in our minds and we from our part, as professional bankers, must endeavor to ensure that they are not repeated. The Central Banks can use both preventive measures and corrective action to maintain financial stability. A constant and continuous monitoring of risks is a preventive measure. Crisis resolution is a corrective action. A strong regulatory regime would ensure the former and a financial safety net is an essential component of the latter. The two supplement each other. The cooperation of all parties concerned in both these actions is of paramount importance in maintaining financial system stability. In Sri Lanka, as in most emerging economies, we have a bank dominated financial system. Therefore, ensuring banking soundness will inevitably lead to financial system soundness. The recent initiatives taken in this regard are significant – we have enhanced capital requirements to reflect the increased leverage in the industry. Even regulatory capital is at a comfortable margin above the international norm but is still only 10% of risk assets which is the absolute minimum should these risks materialize. Therefore, increasing the minimum capital requirements would provide a healthy platform for growth and expansion of banking business. However, capital is the last line of defence. The more immediate needs are good corporate governance and good risk management which will steer the banking system towards good financial health. A sound corporate governance regime would seek to promote the highest standards of professional behaviour and integrity.