nicholas c garganas : recent financial market developments and implications for the euro area and the world economy keynote speech by mr nicholas c garganas, governor of the bank of greece, at the meeting of the international chamber of commerce ( icc ) commission on banking technique and practice, athens, 16 april 2008. * * * it is a pleasure indeed to welcome you to athens for this meeting of the international chamber of commerce commission. this meeting is taking place at a time of turmoil in global financial markets and a significant downturn in global economic growth. i am delighted to have this opportunity to offer some remarks about the present situation and the challenges ahead. we are living in the era of the great globalization and the icc has been an invaluable voice championing the benefits – including enhanced economic growth, prosperity, and job creation – of increased economic and financial integration. while globalization brings important benefits it also, sometimes, brings heightened risks and uncertainties, as recent financial market developments vividly illustrate. the last nine months have been a very challenging period for both policy makers and market participants. during this period, we have witnessed a major reappraisal of risk and a considerable, and still ongoing, turmoil in key financial markets. we have also seen – especially in the us and, to a lesser extent, in the euro area and the rest of the world – downward revisions of growth prospects amid increased risks and uncertainties. in order to be able to ensure that the full benefits of globalization are shared by our citizens, it is necessary to be able to manage the risks and uncertainties associated with globalization. my remarks today, will deal with the origins of the ongoing financial markets turmoil, the policy responses to this turmoil, mainly by the major central banks, and prospects and policy challenges for the euro area and the global economy in the light of this turmoil. greece will, therefore, not be the focus of my remarks this morning. let me just note that greek banks generally have a relatively comfortable capital base and strong profitability, their exposure to u. s. sub - prime mortgage loans has been negligible, while the impact of the international financial market turmoil on the greek banks has so far been indirect and rather contained. however, the financial market turmoil is far from over and there are still risks ahead of us. for this reason, the bank of greece has urged financial institutions to be especially prudent in their portfolio management. origins of the current financial market turmoil although the financial market turmoil

was triggered by problems in the sub - prime loans of the u. s. mortgage market, the origins of this turmoil can be traced to earlier developments. in the four - year period to mid - 2007, the world economy had been characterized by exceptionally benign macroeconomic and financial conditions, as indicated by strong growth and low levels of inflation and ( long - term ) interest rates. such conditions of “ low volatility ” fostered a “ search for yield ”, a rise in leverage to increase returns further, and an underpricing of risk in some key asset markets. these developments were supported by – and, in turn, they encouraged – further financial innovation, as evidenced by the rapid growth in securitization of bank loans, in credit risk transfer instruments and in other complex structured finance products. rapid financial innovation over the last 30 years has undoubtedly benefited the world economy by allowing a deepening of capital markets, easier access to credit by households and enterprises, and a more effective utilization of resources. however, especially in recent years, financial innovation has also been associated with structural weaknesses and complacency in risk management. for instance, the low transparency of these complex products may have made it easier for investors to underestimate the risks they take on. in addition, with prudential regulation sometimes lagging behind financial innovation, some institutions may not have been sufficiently transparent about their exposures to complex structured finance products, on and off their balance sheets. moreover, as such products were often difficult to value owing to inadequate information about the underlying assets, investors often relied too heavily on credit rating agencies. however, the methodology used by the credit rating agencies was not transparent, failing to identify the risk characteristics of the complex structured finance products, including their illiquidity. it is also well known that it was the distorted incentives in the “ originate - and - distribute ” business model of financial institutions that led to a decline in credit standards, the root cause of the “ sub - prime ” problem. more generally, the extent of leverage taken on by banks, bond insurers, hedge funds, and other financial institutions was probably not adequately appreciated, nor were the risks of a disorderly unwinding. eventually something was bound to happen that would trigger a widespread reappraisal of risk, resulting in re - intermediation and de - leveraging. this turned out to be the escalating losses on us sub - prime loans, which showed up in certain hedge funds