is that they will have an impact on financial markets. we know for sure that there will be an impact and we can almost be sure about the direction of some changes. for instance, banks will need to attract more stable long - term funding. at the same time, european insurers, which are important providers of bank funding, show an increasing preference for investment in covered bonds because of the low capital requirements under solvency 2. together with a range of other factors, this will give a boost to european covered bond markets. however, we cannot be sure how large and how permanent the changes will be. that is because there are many different factors at work. some market participants, such as pension funds and other large investors, are much less affected by the current reforms. they will respond to changes in market prices and this may partly offset the impact of new regulations. this makes the overall impact on financial markets uncertain. it is therefore important that major new regulations are phased in gradually. the new liquidity measures for banks provide an example of this approach. they are phased in over four to seven years to prevent large shocks to financial markets. in addition, they are subject to an observation period to facilitate mitigation of undesirable outcomes. a fourth consequence from the current reforms is that the financial system will continue to suffer from important distortions. in other words, there will be incentives for financial institutions to behave in a way that is not in the public interest. of course, this will always be the case. the perfect world of economists, without distortions or frictions of any kind, exists only in their models. still, it is worth pointing out a few important distortions that the current reforms have been unable to tackle. perhaps the most important distortion is that high leverage will remain attractive for financial corporations because interest payments are tax deductible. this makes it attractive for a company to use more debt financing and less equity capital than would be desirable from a social point of view. of course, this distortion exists for non - financial corporations as well. yet in the financial sector it is more troublesome, because tax considerations do not just have an effect on the funding choices, they also stimulate the design of tax - driven financial products. such products may add little economic value, but create leverage and complexity, increasing vulnerabilities in the financial system and making them more difficult to monitor. another distortion is that the current reforms are not uniform across countries. for example, countries

models are a fully intended consequence. if there would be no significant changes to business models, and if that would mean that risk profiles remained too high and potential threats to the stability of the financial system were insufficiently addressed, then we will need to see a further tightening of the rules. the most profound changes to business models will probably not result from capital or liquidity requirements or from other measures to reduce excessive risk taking. instead, the most profound impact will come from resolution measures. that is because effective resolution measures will put an end to the “ too big to fail ” or “ too big to save ” status of systemically important financial institutions. when they loose this status, large financial institutions will also loose important competitive advantages over smaller and less interconnected institutions. at present, systemically important banks enjoy an implicit subsidy on their funding costs. this is apparent in credit ratings, for instance. credit rating agencies assign higher ratings to large banks than their intrinsic financial strength would justify. the rating enhancement reflects the probability of government support and can be as large as five notches. for smaller banks, the enhancement is lower or even zero, because it is perceived that smaller banks are less likely to receive government support when they get in trouble. effective resolution measures will thus eliminate the support - related rating advantage and lower funding costs of large banks. a capital surcharge for systemically important banks fits with this reasoning and compensates for the unfair benefits of being very large. this is a fully intended consequence and will enhance economic efficiency and market discipline. bis central bankers ’ speeches but there may be unintended consequences too. ideally, governments would agree an international resolution framework, but that requires international burden sharing in case they would have to support the restructuring of a cross - border bank. at present, this is not a realistic option. the alternative, national resolution regimes, imply that some degree of autonomy for domestic retail operations may be a necessary precondition for effective resolution. this comes at a cost. financial integration can make financial markets more efficient, especially within a common market like the eu. it enables banks to raise funds where they are readily available and invest those funds where they generate the largest return, even if that is in another country. in addition, banks can diversify their risks by combining retail and investment banking. if the economic benefits from international and universal banking operations cannot be fully realised, that would be an unintended and indeed an undesirable outcome. a third consequence of the current reforms