risk based on one isolated factor could only provide a fragmentary view. what is called for is the “ triangular view of systemic risk ” – comprehensive analysis covering the interrelations or nexus between the banking system, financial markets and the real economy. it is against this background that i think we need to devote at least as much attention to market microstructure as to sophisticated analyses of “ fat tails ” in loss distribution. a focus on market microstructure could shed light on the relations between various risk factors. particularly important is to investigate how individual market participants under different budget and information constraints would behave rationally in stressful events, and how such behaviour would affect the formation of asset prices. strategic interactions recent episodes of financial crises seem to defy explanation on the basis of conventional economic theory, which regards macroeconomic phenomena as a mere aggregate of independent decisionmaking by economic agents. as a reflection of such limitations of conventional theory, there is a growing body of work attempting to interpret financial crises from the viewpoint of “ strategic interactions ” among market participants. i would like to devote a few minutes to outlining why. strategic interaction can be defined as a process in which each market participant explores his / her optimal strategy by conjecturing the response of other participants. some of the papers presented at this conference follow this path. herding behaviour is one example. as you know, a large number of small investors tend to follow a small number of large investors. once stressful events happen, such behaviour is likely to lead to one - sided market sentiment, which accelerates and propagates the stress within and across the markets. from the viewpoint of policymakers, herding behaviour as a phenomenon is hard to tackle. if we understand such a phenomenon as a consequence of strategic interactions among market participants, however, we might find a key to reducing the risk of triggering herding behaviour. according to my reading of this line of research, the outbreak of systemic disturbances would heavily depend on how many market participants, when faced with systemic threats, expect disturbances to actually occur. in other words, a crisis is not necessarily an accident, but a consequence of market participants ’ expectations. their expectations are formed from conjectural views of other market participants ’ responses to such threats. the magnitude of any crisis and the extent of contagion would critically depend on the feedback from market participants reacting collectively to systemic threats. feedbacks could also accelerate any crisis. these explanations seem to offer a useful perspective on the mechanism of

typically costs more than debt. the spread between a bank ’ s own cost of debt, both deposits and bonds etc, and the rate it charges its borrowers has to cover operating costs, expected credit and other losses and the required cost of equity capital. assuming the costs of equity and debt do not change, the more capital intensive the financial structure is, the higher that spread has to be. a requirement to hold more high quality liquid assets and / or to lengthen the maturity of debt has a similar effect. of course the costs of equity and debt may not be, and actually should not be, constant as banking leverage declines. the cost of wholesale debt should fall over time if the equity buffer, which protects unsecured creditors against losses, is larger. in time, the cost of equity may even fall with lower leverage if the required equity risk premium declines to reflect a less variable flow of returns to equity holders. all of that assumes of course that the perceived riskiness of the underlying assets is unchanged. still, such effects would take some time to emerge. most observers appear to agree that even allowing for some possible pricing changes over time, spreads between banks ’ borrowing and lending rates will be wider in the new equilibrium after the regulatory changes have been fully implemented. 3 what will be the broader economic effects of these higher costs of intermediation? by the way, in those countries that choose to impose “ levies ” of some kind or other on banks, we shouldn ’ t assume that the banks ’ shareholders will ultimately bear such costs : it is fairly likely that the costs of this tax will fall mainly on the customers. the conclusion most people are reaching is that economic activity will, to some extent and over some horizon, be lower than otherwise. the question is, by how much and for how long? there are various ways of approaching that question. researchers are putting it to various macroeconomic models. the answers will vary, depending on the models and particularly according to the degree of detail in models ’ financial sectors. overall, these techniques are likely to show moderate but nonetheless non - zero effects on economic activity of the regulatory changes over an adjustment period of several years. some other analyses, often by banks themselves, find much larger adverse effects. this is usually because they find that credit to the private sector must be reduced in order to meet the various standards, particularly liquidity standards, because it is assumed there will be quantity limits on the availability of funding in the form necessary. it is