erkki liikanen : is a reform of banking structures necessary? speech by mr erkki liikanen, governor of the bank of finland and chairman of the highlevel expert group on reforming the structure of the eu banking sector, at a meeting with finance watch, brussels, 20 november 2012. * * * costs of the crisis and the public outcry the global financial and economic crisis which started in 2007 is by far the worst in the western world in the post - war history. the european commission estimates that from october 2008 until october 2010, it has cost 13 % of the european union ’ s gdp in the form of public support to the region ’ s banks. 1 moreover, the present value of lost economic output is probably bigger by orders of magnitude than the direct support. 2 the crisis has caused a public outcry which is justified. regulators are responding to the pressing need to establish a financial system in which losses, not only gains, fall on the private risk takers, not on the tax payer. in order to find appropriate solutions, we need to understand the developments leading up to the global financial crisis. changes in banking in the run - up to the crisis the new landscape in the years preceding the global financial crisis, the landscape of banking had gone through major changes. the banking sector had grown rapidly and global financial institutions had grown ever bigger in size. especially, european banks appear very large when measured in terms of total assets in relation to the domestic gdp. further, the scope and the organizational complexity of global financial institutions had increased, adding to their opacity. there was a trend among the biggest banking institutions to strengthen their focus on investment banking, including trading operations. part of this trend was driven by the growing demand by non - financial firms for risk management services. partly, it was a search for new revenue streams, higher profitability and economies of scale and scope. the flip side of the coin was strong incentives for risk taking. commercial banking moved increasingly away from customer relationship - based banking where loans are granted and then held until maturity to the “ originate and distribute ” model where granted loans are pooled, then securitized and sold to investors. as result, banks became strongly interconnected via increasingly long chains of claims as well as correlated risk exposures, arising from increasingly similar investment strategies. this the final report of the high - level expert group ( 2012 ). see e. g. haldane ( 2010 ) : “ the $

symptoms are of excessive risk - taking, the more likely it is that monetary policy needs to carry a substantial part of the responsibility. the views i have described are by no means novel. in fact, they are not too far off the emerging post - crisis consensus in the central banking community. over the last few years, “ leaning against the wind ” has won many hearts and minds among central bankers and academic economists. my reading of the two papers by brunnermeier and sannikov3, distributed for this event, enforce the points made by woodford : since risk - taking is endogenous, just clearing up the damage in crisis times is not enough, there needs to be some leaning to control the build - up of risks. i don ’ t think we have yet learnt all there is to be learnt about the role of financial stability in monetary policy making. i do however believe that we have learnt enough to know that we should not return to where we were before the crisis. an increased role for financial stability considerations in monetary policy making is likely to be one of the lasting legacies of the crisis. markus k. brunnermeier and yuliy sannikov : “ the i theory of money ” and “ a macroeconomic model with a financial sector ”. manuscripts, 2012. bis central bankers ’ speeches monetary policy stance and implementation another boundary that has been completely redrawn during the crisis is the one between monetary policy stance and implementation. this is the boundary where jose - manuel has been most directly involved during the crisis as the executive board member responsible for market operations since june 2006. before the crisis, monetary policy stance was about setting the key policy rates. everything else was seen as operational implementation with the focus on money market liquidity management. the ecb even had a name for it : the separation principle. according to this principle, the experts working on implementation issues should be separated from the ones assessing the stance, so that the liquidity conditions and shortest market rates would not convey any signals on forthcoming stances. the age of innocence came to an end with the return of liquidity and credit risks to the markets ’ often narrow radar screens. before the crisis, banks ’ demand for liquidity was predictable ; it was set by reserve requirements. during the turmoil, unpredictable precautionary liquidity hoarding emerged as the dominating factor behind the demand. there were two important consequences. first, accurate measurement of the neutral level of aggregate liquidity became impossible ; and