Some of that reflects vulnerabilities in business models and practices of specific market participants: including liquidity mismatch in funds; leveraged and trend-following investment strategies; or insufficiently forward-looking margining practices. But it also reflects a growing imbalance between the size of key markets, and the balance sheet capacity of banks and dealers who have traditionally helped transfer risk smoothly between investors and borrowers (Chart 1).1  Chart 1: Stock of US & UK government bonds relative to bank/dealer balance sheets  Sources: https://www.brookings.edu/wp-content/uploads/2020/05/WP62_Duffie_v2.pdf; UK Debt Management Office; Bank of England Regulatory Returns and Bank calculations. (a) Total assets for the holding companies of Bank of America, Bear Sterns, Citigroup, Goldman Sachs, JP Morgan Chase, Lehman Brothers, Merrill Lynch, Morgan Stanley and Wells Fargo. (b) Based on quarterly averages available from 2008, excluding assets of banking entities authorised to operate in the UK through branches. Gilts outstanding as of end-March 2020. 1  These issues have been discussed in successive Bank of England Financial Stability Reports. For the most recent assessment, see https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2020/august-2020.pdf. 2  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  2  The nature of these vulnerabilities, and the need to consider stronger measures to safeguard financial stability, have been extensively discussed in recent years. But last year’s Covid ‘dash for cash’ was a wake-up call as to the scale and urgency of this work. It is unsurprising that the initial wave of lockdowns last Spring caused a surge in demand for precautionary liquidity.

The Maastricht Treaty, of course, recognised this risk, and the famous convergence criteria were designed precisely as a means of reducing the risk to manageable proportions by requiring that, before they join the euro club, countries should have achieved at least a minimum degree of macro-economic convergence - demonstrating their commitment to macro-economic BIS Review 29/1998  ˝  -3-  discipline through both fiscal consolidation and monetary policy directed at effective price, and exchange rate, stability. And there is no doubt that all European Union member states have made huge progress towards macro-economic stability over the past few years, which you will find documented in the two “convergence reports”. Although the EMI in particular emphasises the ongoing need in a number of countries to persist in determined fiscal consolidation, it is this progress towards nominal convergence that underlies the European Commission recommendation. The nagging doubt is whether this pursuit of macro-economic stability will in fact be maintained - whether the convergence that has certainly been achieved will, in the terms of the Treaty, prove to be sustainable. A particular worry is that macro-economic stability, on its own, has not been enough to prevent the emergence of very high, and very different, levels of unemployment in a number of the major Continental European economies. Unemployment has been for some considerable time, and it remains, much the most urgent and important economic issue confronting us in Europe.