These would include vulnerabilities resulting from global imbalances, growth prospects, developments in housing markets, creditworthiness of borrowers, to name a few. The monitoring involves processing large amounts of (often disparate) information of a statistical nature and is based on market sources. In addition, continuous market intelligence efforts are essential for effective risk monitoring and the early detection of new financial instruments, practices or business strategies which could create vulnerabilities and risks in financial markets. In the case of the Risk Board, market intelligence will be complemented by what could be called “institutional intelligence” and “policy intelligence”, given the qualitative information and expert knowledge available to central banks and supervisory authorities represented in the ESRB. The Board’s independent, impartial status could prove to be invaluable in the surveillance and identification of risks viewed as material. Risk monitoring is facilitated by a large set of tools, including contemporaneous financial stability indicators and forward-looking early warning indicators and models. These tools need to be regularly revised and updated in order to capture innovation in financial markets, fuelled by new products and business models. Macro-prudential indicators comprise a vast set of indicators – on the macroeconomic environment, financial markets, financial institutions and financial system infrastructures. More specifically, they include macroeconomic aspects, financing conditions, monetary conditions, asset valuations, risk appetite, market liquidity, funding liquidity, credit risk, financial strength of institutions, and others.

10 Like pollution, systemic risk involves externalities, in the sense that each financial intermediary manages its own risks but does not consider its impact on the risk of the system as a whole. The financial crisis contributed considerably to a better understanding of the phenomenon of systemic risk, which is also reflected in aspects of regulatory reforms. In particular, the possibility of aligning capital requirements to a measure of firms’ systemic risk contribution is being contemplated by regulators, e.g. the Basel Committee on Banking Supervision. 11 How could the ESRB then structure its supervisory work on systemic risk? In broad terms, systemic risk analysis can be broken down into two core components: i) surveillance, or risk detection, and ii) risk assessment, each of which I will address in turn. Risk detection Financial stability surveillance concerns risk identification. This kind of surveillance mainly aims to detect potential sources of risk, especially financial vulnerabilities – that is weaknesses which, if unearthed, could lead to a disruption or failure in part of the financial  7  De Bandt, Hartmann and Peydró-Alcalde (2009), “Systemic risk in banking: An update”, forthcoming in the ECB Working Paper series, and Berger, Molyneux and Wilson (eds. ), Oxford Handbook of Banking, Oxford University Press. This paper surveys all the relevant academic research with respect to the three categories and relates them to the present crisis where applicable.