time alleviate the problem of weak profitability in the remaining banks. in addition, we need a developed european capital market, which also provides capital to young, ambitious and risk - taking firms in europe and continues to finance them throughout their growth phase. a functioning capital market is necessary for mastering the enormous challenges facing us today : climate change, digitalisation and demographic trends. the european capital markets union can play a significant role here. monetary policy and asset price bubbles the last narrative i would like to discuss this evening is the claim that loose monetary policy leads to price bubbles in the financial and real estate markets. fears that monetary policy entails risks for financial stability should indeed be taken very seriously. in fact, one objective of the current expansionary monetary policy is to revive risk appetite among investors, and thus promote growth and investment activity. it is normal for asset prices to rise during phases of low interest rates. equity prices, for example, reflect firms ’ discounted earnings expectations. if the interest rate falls, equity prices will go up, because future earnings will have a greater bearing on current valuations. however, earnings expectations themselves also tend to increase when interest rates are lowered, because investors anticipate stronger economic growth. and, indeed, the current price / earnings ratio in the euro area is a long way off from the excesses of the dotcom bubble of 2000, and it is closer to its historical median than in other economies ( slide 25, left - hand side ). nonetheless, central banks need to keep a close eye on such valuations, as purely liquidity - driven price gains can result in risks for financial stability in the long term. asset price bubbles pose a particular risk when they are largely credit - driven. this is typically more likely to apply to real estate than to equities. that is why developments in real estate prices are rightly coming under particular scrutiny. residential real estate prices in germany have risen appreciably in recent years, especially in the larger cities, and the deutsche bundesbank has repeatedly pointed to possible price excesses. two factors are significant here. first, prices always reflect the interplay of supply and demand. the pronounced price increase in german towns and cities reflects a noticeably stronger demand for housing that was unmatched by any corresponding expansion of supply. there was a stronger influx of people to the towns and cities and a simultaneous increase in the demand for housing space per person. the low interest rates are likely to have further fuelled the demand

report ( although some of the recommendations touch on it ) because of the urgency of making concrete recommendations in other areas. but now it is time for us to return to this topic. as in the areas that i described earlier, the goal will be to strengthen the resilience of the system without hindering the process of market discipline and innovation that are essential to the financial sector ’ s contribution to economic growth. there is no shortage of ideas around for which aspect of procyclicality is most relevant for financial stability, and for the range of policy options that could help dampen procyclicality. some of the areas that we in the fsf have decided to look at include : • the capital regime : the basel ii framework ties required capital more directly to the perceived riskiness of an asset, which is likely to increase during downturns and fall during expansions. this is not new, but because basel ii itself is new there is more we need to know on the mechanics – it is not clear yet, in particular, how required, desired and actual capital levels will evolve over a full cycle under basel ii ( although a framework is now in place for tracking and assessing this ). as we consider how to strengthen the regime, more thought needs to be given to how to promote higher buffers above the regulatory minimum in good times, which can then be dipped into more flexibly during cyclical downturns. to a degree, this is already possible in a discretionary way, although too much divergence in national implementation of basel ii would raise issues of transparency and consistency in international regulatory arrangements and should therefore be constrained. ad hoc, uncoordinated reductions in required minima could be viewed as forbearance and could give the wrong signal about authorities ’ judgement as to the overall strength of the system. how we can best dampen procyclicality in bank capital is an inquiry we are now engaging internationally and in the european context in a coordinated fashion. • a related issue is sound loan - loss provisioning : these are useful tools to counter the effects of procyclicality, especially on new lending. however, our banking systems came into this crisis with historically low levels of provisions. to a degree, this can be attributed to the benign recent default environment. but it also reflects new accounting principles and prudential rules, the effects of which we need to assess in the light of experience. our aim must be to create scope to promote