jose manuel gonzalez - paramo : liquidity, funding and solvency – policy responses and lessons speech by mr jose manuel gonzalez - paramo, member of the executive board of the european central bank, at the universidad de alcala de henares, madrid, 16 january 2009. * 1. * * introduction ladies and gentlemen, it is a great pleasure for me to participate in this conference of universidad alcala de henares, together with so many distinguished speakers, and share with you some considerations about the responses of the eurosystem and other public authorities to the financial market crisis as well as on some of the lessons that we have drawn. i am very grateful to the organisers – foro de economia del centro de politicas publicas uah and, in particular, its director rodrigo rato – for giving me the opportunity to address you today. after one year and a half from the start of the turmoil, the international financial system continues to undergo a period of severe adjustment. the global money and credit markets are still impaired by the effect of high uncertainty about the solidity of financial and banking institutions and their ability to withstand the consequences of both the vulnerabilities at the root of the current crisis ( such as the exposures to the us sub - prime mortgage market ) and new shocks stemming from the ongoing slowdown in economic activity. indeed, the deterioration in credit supply conditions, together with falling asset prices, exceptionally high uncertainty and declining confidence, has fed back into economic activity, leading to a severe worsening of the outlook for economic growth in both developed and emerging countries. of particular concern for central banks is the persistence of tensions in global money markets, where market liquidity has come under severe stress and term interest rate spreads remain at levels that – though significantly lower than three months ago – are nevertheless elevated by historical standards. other important segments of the global financial system, such as the markets for equities, bonds and commodities, have also entered a period of considerable turbulence and stress. in my intervention today, i will focus on what the ecb has done from the beginning of the financial market turmoil to contribute to the smooth functioning of the euro area money markets and to mitigate funding shortages of euro area banks. 2. the financial market turmoil and policy responses from the eurosystem the turmoil over the last year and a half has hung on our economies like a dark cloud, prompting central banks and other public authorities to undertake measures that have in some cases been

if the speed is no longer in line with the driver ’ s capability and external conditions. using this analogy, how does the current situation in the global financial markets and swiss banking sector compare? as already mentioned, the overall impression at the moment is that we are driving quite fast. unlike on the motorway, however, there are three reasons why it is difficult to judge if the speed is too high or if the market participants would be able to slow down in time were conditions to deteriorate. firstly, it is not clear just how fast the car is going, or rather, how much risk is being entered into. this not only applies to the less regulated players in the financial system, such as hedge funds, but also to a certain extent to banks. for instance, the rating agency moody ’ s came to the conclusion in a report 1 published last year that banks generally do not disclose their risks sufficiently. in our financial stability report, we also point out that it would be beneficial if swiss banks were to provide more data in this regard. by providing more comprehensive data, banks would be helping investors and authorities to better assess the risks banks take. banks should, for example, publish more results from their stress tests. similar to crash tests, stress tests examine how severely the bank would be affected by a major crisis. secondly, it is difficult to assess how the traffic would react in poor weather conditions. even though the braking distance is relatively short on a dry surface, this is by no means a guarantee that the car will react in the same way on a wet or even icy road. a number of instruments currently in use in the financial system have not yet had to prove their worth in extreme stress situations. it is therefore not clear whether the risks for these new and complex products have been adequately assessed. these products are typically not assessed in a central market, but by using complex models. in other words, the analysis is not a mark - to - market one, but a mark - to - model one. the reliability of the mark - to - model approach, however, relies heavily on assumptions and on the availability of reliable data. data on tail events ( events that occur rarely, but have major repercussions ) would be particularly beneficial for the calibration of models. there is, however, by definition hardly any data on such events. this begs the question as to whether the dangers associated with tail events are being correctly assessed using the available models, or whether model risks pose a