That said, the new prudential legislation admittedly entails considerable challenges as to its implementation, and its introduction will restrict the capacity of banks to run risks. For this reason, it is appropriate, especially taking into account the relatively weak economic activity in Europe at present, to consider prudent implementation timetables taking advantage of the flexibility in the Basel Accord and in the new European solvency legislation. 2  BIS central bankers’ speeches  We should apply the same prudence in the introduction of the new leverage and liquidity requirements. The observation periods currently in force should be used to painstakingly assess the resulting effects and, in particular, to better understand the possible interaction between the two tools. Finally, in the area of the implementation of Basel III, we should not forget that there is still one issue to be resolved. It is important to ensure that the application of the new capital rules yield results which are comparable and consistent across institutions and countries. Specifically, the capital requirements for two institutions with a comparable risk profile should be similar, irrespective of the jurisdiction or jurisdictions in which they operate. In particular, although progress has been made recently in this area, additional effort is required to ensure that the internal models used by institutions and authorised by their supervisors to calculate risk weightings do not produce uneven results which question the robustness of the solvency ratios and introduce competitive distortions.

In the case of liquidity, the shortcomings of our analytical tools are magnified by the difficulty of measuring leverage or identifying potential concentrations in the financial system. This has always been challenging, but the growth in the overall size of private pools of capital and the degree of embedded leverage that exists in many derivative instruments makes this more challenging today. When market liquidity and funding seem abundant, this is likely to be observable in things we can measure, like interest rates and credit spreads. And when liquidity ebbs, the effect is conspicuous in a range of observable market prices and volumes. But we do not have, and probably never will have, a set of indicators that offers the promise of predicting when liquidity conditions will reverse, or when markets are particularly vulnerable to a more acute decline in liquidity. In this sense, liquidity is like confidence. And, like confidence, liquidity plays a critical role both in establishing the conditions than can lead to a financial shock, and in determining whether that shock becomes acute, threatening broader damage to the functioning of financial and credit markets. What role can policy play in reducing the vulnerability of markets to this type of dynamic? Of course, central banks have a range of instruments they can use in the event of a crisis. By injecting liquidity into the system, and thus strengthening confidence, they can reduce the risk that temporary liquidity problems will result in default by otherwise solvent institutions, or damage to the payment system or credit process.