to assess a number of other topical policy issues. these include : central clearing : central clearing of financial transactions tackles the complexity of, and concentration within, the financial system at source. the dense knitting of the financial web is unravelled and replaced with a simple hub - and - spokes topology. this will tend to reduce the liquidity hoarding incentives of investors, so making for more resilient funding markets in the event problems strike. provided the central clearing house is beyond reproach, this topology also reduces the contagious consequences of individual bank stress : liquidity cascades are headed - off at the clearing house. the proviso is important, though. robustness of the central clearing basket becomes more important as more eggs are placed in it. this calls for a seachange improvement in risk management practices among the clearing houses, as more financial transactions come to be centrally cleared to meet g20 commitments. otherwise the too - important - to - fail problem simply re - emerges in a different guise. liquidity policy : one implication of the model is the importance of banks maintaining buffers of the highest - quality liquid assets. these have a doubly beneficial effect. first, they reduce banks ’ need to hoard liquidity in situations of stress. second, high - quality assets reduce the amplitude of the haircut cycle in the first place, as table 1 demonstrates. the first reduces the impact of a liquidity event, the second its probability. the upshot is a fall in the chances of a systemic liquidity crisis. the new basel iii liquidity regulation uses a strict definition of what counts as liquid assets. the model underlines the importance of sticking to that definition. the model suggests that financial system robustness would be further enhanced by bis central bankers ’ speeches targeting liquidity requirements on the most connected banks in the system, as this would lean against the destabilising effects of system - wide concentration. hot heads make for bad decisions, frozen ears for uncomfortable ones. financial markets have felt the effects of this change in the weather more dramatically than most. suitably designed, macroprudential policy can help moderate those swings in temperature, thereby improving the health of the financial system. bis central bankers ’ speeches

bonds high - yield bonds g7 countries equity source : committee on the global financial system ( 2010 ). prime counterparty. bis central bankers ’ speeches this haircut cycle played an important causal role in the crisis. secured financing became an increasingly important source of credit in both bank and non - bank markets over the past decade. in the us, the repo market financed roughly half of the growth in investment banks ’ balance sheets between 2002 and 2007. in the uk, the securitisation market trebled in size over the same period. those were the heady days of summer. since then the us repo market has shrunk by 40 %, while the uk securitisation market remains frozen. pro - cyclicality in the haircuts applied to secured financing transactions in turn amplified the cycle in credit. thin haircuts made it cheaper for banks to mobilise collateral to finance borrowing when the credit cycle was in the upswing, adding momentum to the upward pendulum of asset prices and credit. and fat haircuts immobilised collateral when the credit cycle reversed, exaggerating the downward pendulum swing. a further factor amplifying these swings came from the fact that much of the secured financing took place within the financial sector. in the run - up to crisis, banks and near - banks entered into secured financing transactions with one another, inflating both counterparties ’ balance sheet. in the uk, fully two - thirds of the trebling in balance sheets between 2002 and 2007 can be explained by expanding claims on other parts of the financial system. these cross - system dependencies in financing have “ externality - like ” effects. during a generalised boom, individual banks lend freely to one another and all of the moving parts of the financial system are lubricated. the system co - ordinates itself on a high liquidity equilibrium. liquidity has positive spillover effects or externalities ; liquidity is a public good. and with rising asset prices and liquidity and falling haircuts, the credit multiplier is high and self - reinforcing. but that cycle can just as quickly reverse. in a situation of stress, individual banks hoard rather than lend liquidity. the system then co - ordinates itself on a low liquidity equilibrium. liquidity then has negative spillovers, imposing negative externalities ; illiquidity is a public bad. and with asset prices and liquidity falling and haircuts