##o markets have been under great strain. during the most intense periods of the crisis around the collapse of bear stearns in march 2008 and lehman brothers and others in the fall of last year, these markets seized up entirely : good collateral became unfinanceable overnight, firms failed, and risk aversion across all financial markets skyrocketed. this crisis of confidence was less acute in canada, but still produced severe strains in our wholesale funding markets. heightened uncertainty made counterparties reluctant to extend financing beyond the shortest maturities, resulting in intense funding pressures for canadian financial institutions. banks cut back their market - making activities in order to conserve balance sheet capacity, which further aggravated market volatility. these dynamics raised the risk of an adverse feedback loop between the financial system and the real economy. the bank of canada responded to these pressures by dramatically expanding our liquidity facilities, and the government of canada implemented a program to purchase insured mortgages with the help of the canada mortgage and housing corporation, thereby increasing the access of canadian institutions to longer - term financing. reflecting both the strength of our banks and the scale of our actions, conditions in canada have been consistently better than elsewhere ( chart 3 ). since december, these policies have gained considerable traction, helping to reinforce the improvement in domestic funding conditions as the global financial crisis subsided ( chart 4 ). this improvement has been reflected in a decline in the spreads on bank financing in money markets, a moderate extension of maturities, and a substantial reduction in the cost of term funding for canadian banks. in addition, policy initiatives have allowed banks to increase substantially their holdings of government securities, which has helped boost their liquidity situation in a capital - efficient way. these improvements have been further supported by strong growth in retail deposits and slowing credit growth ( chart 5 ). market - making activity in canadian financial markets has also been recovering, although it remains less than satisfactory. policy response there are important lessons to be drawn from this experience. the performance of core funding markets during the crisis intensified the financial panic and helped trigger the recession. this is totally unacceptable. as a consequence, one of the bank of canada's top priorities is to promote institutional changes to create more robust core funding markets. promising avenues to break such ( il ) liquidity spirals include introducing clearing houses, standardizing products, implementing through - the - cycle margining, and ensuring more effective netting. as the ultimate provider of liquidity to the system, the bank is thinking through whether

to adapt its facilities to support continuous private liquidity creation. bank capitalization since the crisis began, the capital adequacy of banks around the world has been the subject of intense scrutiny. concerns moved quickly from bank exposures to u. s. subprime debt on to structured products of all types as the crisis spread and, finally, to more traditional credits to businesses and households as the recession took hold. concerns about capital adequacy for banks outside canada were made worse by uncertainties caused by accounting standards, valuation methodologies, and a loss of credibility of the basel ii regulatory capital standard. it was not lost on investors that every single financial institution that failed had a capital ratio well above its basel ii regulatory minimum the day before it went down. as a consequence, investors have demanded ever - higher capital ratios from all banks, creating a dynamic that has exacerbated the recession. in this context, canadian institutions have benefited from several factors : high initial capitalization ( minimums set by the office of the superintendent of financial institutions are well above the basel threshold ), high - quality capital ( with one of the highest proportions of common equity ), the clarity provided by a simple leverage cap, low exposure to structured products, and clear valuation and disclosure standards ( including rapid implementation of the financial stability forum's enhanced disclosure guidance of april 2008 ) ( chart 6 ). writedowns by canadian banks have been relatively moderate to date, reflecting their conservative lending practices and low exposure to highly impaired asset - backed products. but canadian banks, as the principal source of finance in our economy, are still exposed to the risk of a marked deterioration in economic conditions, which would depress earnings and generate losses in their household and corporate loan portfolios. in general, this risk is why banks carry high capital buffers. the macroprudential risk is that these capital buffers may not be allowed to play their intended role in absorbing these losses because of market pressures to maintain inordinately high capital ratios. this could force banks to curb balance sheet growth, causing a tightening of credit conditions that would reinforce the negative impact of the economic downturn on the financial system. reflecting the generalized nature of the financial panic, as the crisis unfolded, canadian banks came under pressure from markets to increase their capital ratios. in response, canadian banks raised significant additional, high - quality capital from private sources. the recent improvement in market sentiment has been reinforced by the release in may of the stress -