Finally, we should not underestimate the importance of users themselves building resilience within their own operations to single points of failure in infrastructures. For the very same reasons that monopoly infrastructure providers may tend to under-invest in resilience from a public policy perspective, even where run as user-owned cooperatives, financial institutions might also need supervisory encouragement to invest in work-around measures to deal with disruptions at the level of the core infrastructure. Other sources of systemic risk The existence of single points of failure is not the only manifestation of systemic risk in infrastructures, as the behaviour of agents within the systems can lead to problems spilling over to other participants given the interconnections and strategic interactions. For example, if a large net provider of liquidity to a real-time gross settlement payment system were to face severe operational difficulties which left it unable to make payments, other banks within the system might find themselves short of liquidity, and, in extremis, some might be unable to meet their own payment obligations. Behavioural responses, such as payment delays and liquidity-hoarding, might then exacerbate the problem within the payment system, potentially also spilling over to activity in other systems and financial markets. And, where a system is integral to the implementation of monetary policy, a disruption could directly affect a central bank’s ability to set overnight rates and maintain confidence in the currency. Although this variant of systemic risk does not originate directly in infrastructures, system design can, nonetheless, help mitigate the impact.

Systemic stress-testing As financial markets evolve and new vulnerabilities are exposed, it becomes increasingly important that both market participants and the public authorities improve their understanding and assessment of threats to financial stability, and take steps, where appropriate, to contain and lower them. The Bank of England has been active in the development of models to identify and assess potential sources of major vulnerability to the UK financial system 2 and is, with the Financial Services Authority, engaged in a dialogue with practitioners, both to understand better current approaches to measuring risks under stressed conditions and to encourage improvements and the sharing of best practice in stress testing techniques. Recent distress in the US sub-prime lending market, and the collapse of the hedge fund, Amaranth, have exposed weaknesses in risk management, including in the management of contingent, or offbalance sheet, exposures. Although developments in the sub-prime market of course continue to unfold, the impact on conditions in broader financial markets has to date been relatively contained. But, in a more severe stress scenario, perhaps in a more significant market such as corporate credit, or one in which several areas of vulnerability were exposed in combination, the impact could have more serious consequences for the financial system. This highlights the potential value of a more rigorous assessment of tail-end risks. In particular, stresstests by financial institutions should attempt to incorporate the behavioural responses of other firms which may have a substantial impact on market conditions.