vahur kraft : safeguarding financial stability – key issues for the central bank speech by mr vahur kraft, governor of the bank of estonia, at the conference on the challenges for the unified financial supervision in the new millennium, tallinn, estonia, 2 july 2001. * * * good afternoon, ladies and gentlemen. after the most interesting presentation by minister kallas, it is my pleasure to address this distinguished audience on more general issues. departing slightly from the pre - announced agenda, i will discuss the key challenges to maintain financial stability from the central bank's point of view. i. why is the central bank interested in financial stability? the question " why is financial stability so important for the central bank " does not need to be discussed here in detail. monetary transmission can not be efficient if weak financial system distorts interest rate signals by increasing margins or if the financial markets have ceased to function as some participants do not trust other players. the causality can run also in other direction. over the past decade, we have once and again witnessed how weak financial systems have directly caused the currency crisis that resulted in capital flight, devaluation and deep recessions. the latter is particularly relevant for fixed exchange rate systems. and finally, central banks are interested in financial stability because often the central banks would have to take the leading role in crisis resolution, by providing emergency assistance and working out restructuring plans. these concerns are very familiar to bank of estonia. fixed rate of estonian kroon and the currency board to support the peg necessitates in strong financial system for several reasons. in the open economy, if the exchange rate is fixed, the interest rates should be let to fluctuate, from time to time within wide margins, to meet the market supply and demand for estonian assets. that monetary transmission channel from the rest of the world – in our case from the ecb in frankfurt – to estonian economy is of vital importance to provide early signals to address emerging imbalances. financial system is, thus, both the messenger and the first line of defense, as the banks have to withstand volatile interest rates in case of negative expectations and resulting market uncertainty. lack of lender of last resort even more underlines the essential role the financial stability plays to avoid domestic currency crisis. as minister kallas vividly explained, we have gone through lot of experiences over the past decade. at the outset of east - asian crisis, estonian currency system survived the speculative attack that we at these times considered

has resulted in rapid increase of cross - border ownership. the question of co - operation between central banks and supervisors is the key to maintain sound financial systems. that applies both to crisis prevention as well as to crisis resolution. how to pass on early warning signals, how to provide emergency liquidity support, how to restructure or wind up big financial conglomerates – these questions are highly relevant for us as well as for the whole common market. i believe this a good time to stop and pass the word over to our moderator who will elaborate more thoroughly on the other mission impossible : how to find a right institutional structure for financial sector supervision. thank you for your attention.