provide a liquidity backstop to solvent firms. for example, the central bank could commit to being the lender of last resort as long as it judged the firm to be solvent and with sufficient collateral. this would reduce the coordination problem and the risk of panics sparked by uncertainty among lenders about what other creditors think. if the central bank is willing to provide backstop liquidity, then a lender that judges the financial firm to be solvent should be willing to lend. the backstop liquidity ensures timely repayment. the lender of last resort role eliminates the externality in which the expectations about the willingness of one lender to lend influences the decisions of others. however, providing a liquidity backstop is not without its own set of problems. if firms have liquidity backstops that are viewed as credible, then this creates moral hazard. firms do not have to worry as much about what lenders think about their capital adequacy or the size of their liquidity buffers. this creates incentives to run leaner in terms of capital and liquidity, which increases the risks to the backstop liquidity provider. to mitigate such effects, the backstop liquidity provider could presumably charge financial firms for the value of the backstop. but what fee would be appropriate? it is difficult to assess the probability of financial panics and the value of backstop liquidity facilities. 7 fifth, regulators could take steps to reduce the difference between the value of the firm dead versus alive. for example, we could improve the resolution process so that less of a firm ’ s value is destroyed by the liquidation process. if we could reduce the difference in value between a firm as a going concern versus the same firm in liquidation we could reduce the severity of the cascade effect when financial conditions deteriorate. sixth, we could make structural changes to the financial system to make it more stable in terms of liquidity provision. for example, consider the three structural issues outlined earlier that amplified the crisis – tri - party repo, collateral requirements tied to credit ratings, and haircut spirals. in the case of tri - party repo, the amplifying dynamics could be reduced by enforcing standards that limited the scope of eligible collateral or required more conservative haircuts. formal loss - sharing arrangements among tri - party repo borrowers, investors, and clearing banks might reduce or eliminate any advantage that might stem from running early. eliminating the market ’ s reliance on intraday

that the separation of responsibilities and powers can only function on a basis of close cooperation and trust. i should like to touch upon two areas in which fundamental changes are needed. first, the financial systems have obviously been becoming more complex with regard to the roles played by their major participants. the traditional approach of focusing supervisory activities on the banks thus seems less and less appropriate. a more comprehensive supervisory system, covering the financial markets as a whole, would be preferable, with particular attention being paid to the transparency of market activities. moreover, bank supervision should take account of the increasingly international nature of the financial markets. there would appear to be good reason to call for a globalisation of the supervisory system. but globalisation is one of those “ in ” words that has to be treated with caution. as a matter of fact, individual financial markets are still embedded in a national economic and social environment. what we need is for cooperation between the national supervisory bodies to be gradually intensified - which is in fact happening. true supranational supervision is still a long way off, as the necessary economic and social framework is lacking. for this reason, i should now like to focus on the role that an individual central bank has to play in helping to safeguard the stability of the financial system. i have already spoken about the general prerequisites needed for a financial market to flourish. within the scope defined by the operating conditions mentioned, market players are basically responsible themselves for what they do or don ’ t do. their prime concern is to stay solvent at all times by adopting sound business practices and putting an effective organisation in place. to prevent problems from occurring, the responsible bodies at the individual banks must be able at all times, and with a minimum of delay, to accurately assess their risk situation and to take rapid and appropriate action. of course, it is never possible to rule out the possibility of an individual bank running into difficulties. in such cases, a solution must first be sought through the market. solidarity among the other market players should provide a “ first line of defence ”. seeking funds from the central bank can only be contemplated in the last instance - hence the expression “ lender of last resort ”. obtaining credit from the central bank presupposes that the liquidity requirements are only temporary. if the solvency of a - 4bank is in peril because of a threat to its capital, the problem is a matter for the supervisory authorities and possibly for the state itself. in practice,