Let me now move on to discuss some of the things that can go wrong when controls break down. I will not go into particular case studies, but will try instead to draw together some of the common threads of recent problem bank cases. The Basle Committee paper that I mentioned earlier suggests five such common threads, and I will draw on this in the following remarks. BIS Review 48/1998  -3-  The first, which I have mentioned already, is lack of adequate management oversight and accountability, and failure to develop a strong control culture within the institution. Without exception, a common feature of recent problem bank cases has been management inattention to, and laxity in, the control culture of the institution, insufficient guidance and oversight by the Board of Directors and senior management, and a lack of clear management accountability through the assignment of roles and responsibilities. These cases also reflect insufficient incentives to carry out strong line supervision and maintain a high level of control consciousness within business areas. The second thread is inadequate assessment of the risk of certain banking activities, whether on or off balance sheet. Many banking organisations that have suffered major losses neglected to continually assess the risks of new products and activities, or update their risk assessments when significant changes occurred in the environment or business conditions. Many recent cases highlight the fact that control systems that function well for traditional or simple products are unable to handle more sophisticated or complex products.

While the nature of shocks and propagation mechanisms still largely remain on the battlefield of economic theory, empirically observed patterns and the consequences of the materialisation of risks necessitate our reaction, which should be based on our best knowledge and abilities. Allow me to get into more detail here. Optimal policy responses in a multi-country setting require a careful examination of real and financial cycles, both domestic and international. For that purpose, let us look at five important patterns that seem to characterise them. First, financial cycles seem to have a lower frequency and higher amplitudes compared to standard business (real) cycles. Credit and asset price cycles may take long to develop their potential to destabilize the financial system. Further on, such a potential may emerge regardless of watchful micro-prudential supervision or stable inflation. The resulting notion of systemic risk may be identified as the interplay of macroeconomic shocks that make financial sector vulnerable, the contagion resulting from financial interconnectedness and endogenous financial imbalances associated with credit booms, credit leverage and risk taking behaviour of financial institutions 3. Second, there are still no mechanisms in place to engineer sustainable synchronisation of cyclical movements across Europe. The question of cyclical synchronisation arises as particularly important within the international setting. This is the factor that makes policy responses even more complex, especially within a currency union such as the euro area, where the damage of suboptimal policy responses might exceed mere fiscal costs and output losses – they may threaten the future of the euro itself.