. it is also an essential requirement for the proper conduct of monetary policy and therefore also for successful future participation in the euro area - once the necessary conditions have been fulfilled. the creation of deep and liquid capital markets is an important factor enabling an efficient use of indirect and market - based instruments in the conduct of monetary policy. it furthermore strengthens compliance with the rules relating to the prohibition of privileged access to the financial system. finally, structural weaknesses in the banking sector could also have severe implications for the monetary policy transmission mechanism, affecting the responsiveness of banks to changes in the monetary policy stance. efforts to strengthen the financial sector and the banking system need to be undertaken in the years ahead, not least in fulfilment of the so - called " economic " copenhagen criterion. this criterion requires the existence of functioning market economies and the capacity to cope with competitive pressures. while it is undoubtedly a difficult task, compliance with this criterion is an essential step towards integrating into the single market and, in this way, towards creating a solid basis for future noninflationary growth. * * * 2. in the second phase of the aforementioned three - stage process - starting immediately upon accession into the eu - the new entrants will, as far as emu is concerned, have the status of " member states with a derogation ". no " opt - out " clauses will be available for the future new members. as from their entry into the eu, the new member states will be obliged to treat their exchange rate policy as a matter of common interest. this implies, for example, that competitive devaluations are not allowed, since they would interfere with the smooth functioning of the single market. bearing in mind the final objective of adopting the euro, we expect accession countries to join erm ii, when they have achieved a sufficient degree of convergence with the euro area. this mechanism can accommodate different exchange rate regimes including euro - based currency board systems, provided that they are compatible with its key features and that the policy objectives are in line with those of the mechanism and with participation in the single market. the only clear incompatibilities with erm ii that can be identified at this stage are the cases of free floating, crawling pegs, and pegs to reference currencies other than the euro. most accession countries have already indicated their intention to join the mechanism as soon as possible after entry into the eu. in this context, i should like to stress that the experience of

the assessment of the prospects for the financial markets and for deriving some lessons. at the early stages of the crisis, when it was still contained to the us sub - prime mortgage markets, delinquency rates on us sub - prime mortgages increased markedly after mid - 2005, for two main reasons. first, the interest rate charged on sub - prime mortgages is initially much lower than for a standard mortgage, but it is typically reset to a much higher rate, usually after a two to three year period. second, high rates of house price inflation since the early 1990s had encouraged some households to borrow for house purchases with the intention of refinancing, or repaying the mortgage, before the reset date. once interest rates on these mortgages started to rise, and house prices began to moderate and subsequently to fall, many borrowers were unable to service their loans, sometimes even before the reset date if they had been aggressively betting on further house price increases. the developments in delinquency rates and house price inflation are shown in the charts on slide 5. what are the prospects for the sub - prime mortgage markets? recall that the typical fixedrate period for adjustable - rate mortgages is two to three years, after which they are reset and tied to one of a number of common indices, which are closely related to market interest rates. notwithstanding a slight decrease in these indices as of recently, an estimated usd 400 billion of sub - prime mortgages will face a reset in interest rates over the next two years. the surge in delinquency rates quickly translated into falling values of residential mortgagebacked securities ( rmbss ), especially those backed by the most recently originated vintages of loans. the values of such securities, and the indices of credit default swaps ( cdss ) on such securities, have mostly continued to deteriorate until today ( see chart on the left of slide 6 ) ; box 2 of the review examines these issues in detail. the fact that claims on the cash - flows generated by sub - prime mortgages were embedded in a broad array of structured credit products, often layered on top of one another, explains why the unexpectedly severe credit losses on the underlying us sub - prime mortgages and the risk of potential future credit losses had such widespread effects on the financial system. the announcement by some rating agencies in early july that they would downgrade many asset - backed securities ( abss ) and collateralised debt obligations ( cdos ) backed by