allotted to me, i will reflect on the experiences of the recent financial crisis, and begin by summarizing the changes in central banks ’ llr function. that will be followed by a discussion of a few issues pertaining to the llr function that have become apparent. i will then conclude by reflecting on the roles the central bank should play in order to safeguard the stability of the financial system and the real economy. ii. the transmutation of the llr function the purpose of the llr function is to prevent the manifestation of systemic risk, that is, the risk that a problem in one part of the financial system spreads to the whole system in a domino - like fashion. the classic description of systemic risk focuses on contagion, where a bank run could affect other domestic banks in the system through a decline in funding liquidity. in contrast, the recent financial crisis revealed that, in the light of deepening financial markets and globalization, systemic risk can ( a ) be magnified through mutually walter bagehot ( [ 1873 ] 1924 ), lombard street : a description of the money market, london : john murray. bis central bankers ’ speeches reinforcing declines in funding and market liquidity ; and ( b ) spill over across national borders and have a global dimension. central banks ’ llr function has evolved in response, encompassing the roles of “ market maker of last resort ” ( mmlr hereafter ) and “ global lender of last resort ” ( gllr hereafter ). mmlr from the summer of 2007, market liquidity dried up in the u. s. and european interbank market as the problems in the sub - prime mortgage sector spilled over into other sectors, which in turn increased the precautionary demand for liquidity and heightened counterparty risk. at the same time, investors ’ risk appetite plunged, resulting in a decline in market liquidity not only in the securitization markets but also in markets for risky assets in general. financial institutions that had accumulated such assets on their balance sheets were increasingly hard pressed to finance such positions even for the short term. with liquidity in the interbank market severely impaired, funding became ever more difficult, and financial institutions were forced into stepping up their sales of safe assets, whose markets remained relatively liquid. this, in turn, eroded the liquidity in the markets for relatively safe securities and prevented the functioning of repo markets that used those securities as collateral. it was a vicious cycle

bank steps in to provide liquidity as mmlr, market liquidity will not automatically improve. as a result, the central bank will face a difficult decision as to how far it is prepared to go. depending on its own actions as mmlr, not only will those actions affect the stability of the financial system and the effectiveness of monetary policy, but they will also endogenously influence the central bank ’ s own financial soundness. if the central bank ’ s actions as mmlr are able to set in motion a process of reviving market liquidity, the market prices of the assets that the central bank had purchased or accepted as collateral will stabilize, thus safeguarding its equity capital. if, in contrast, the central bank attempts to defend its balance sheet – and hence the confidence in the central bank – and limit its capital exposure by holding back on liquidity provision as mmlr, market liquidity might continue to decline, which would, in turn undermine the value of the assets that the central bank had purchased or accepted as collateral, eventually risking a hit to its equity capital. an erosion of the central bank ’ s financial soundness resulting in a loss of its credibility may compromise its ability to implement monetary policy and ultimately the effectiveness of such policy. in addition, losses incurred by the central bank would hurt taxpayers as transfers to the government are reduced and its actions as mmlr would inevitably impinge upon microlevel resource allocation, which implies that they are quasi - fiscal measures ( chart 4 ). at the same time, however, it is also undesirable to see the central bank not acting sufficiently forcefully as mmlr in order to minimize hits on its balance sheet. in this context, when the federal reserve introduced the term asset - backed securities loan facility so as to restore liquidity in the abs market, it was agreed that the u. s. government would shoulder losses up to a certain level. in the case of the asset purchase programme of the bank of england, this is based on the agreement that any losses will be borne by the u. k. government. in the case of the bank of japan, when it decided to embark on a program of purchasing corporate financing instruments in 2009, the japanese government noted at the monetary policy meeting that it intended to consult with the bank of japan in the context of closing its books at the end of accounting periods if the risks had materialized. the financial trilemma and cooperation among central banks with regard to the stability of the financial system