] as a result, many large and complex financial institutions appear to have benefited from cheap funding, thanks to such too - big - to - fail expectations. 9 cheap funding which is insensitive to balance sheet risks may easily spur risk - taking, especially when banking competition gets tougher. sheer ignorance by bank managements of the true risks may also have played a role. 10 [ slide 9 – market discipline vs. structure of banks – a “ chicken - and - egg ” problem to be solved ] the too - big - to - fail assumption weakened market discipline, as did the opacity of large, complex financial institutions. as a result the banking sector has not been renewed or restructured in a way that might have happened in a world with efficient market discipline. inefficient business models have not been outdated in the same way as they have been done in the corporate sector, where the conglomeration trend of the 1980s reversed already some time ago. the market indications of a diversification discount appear to be too weak. 11 the challenge at hand is thus to implement regulatory reforms and policies which help steer the financial sector and banks towards a size and structure, which in a better way support economic growth while maintaining financial stability. no one really knows what the right size this refers to the era which is known as the great moderation. see e. g. borio ( 2003 ), “ towards a macroprudential framework for financial supervision and regulation? ”, cesifo studies, 49 ( 2 ) and the june 2013 imf - report “ key aspects of macroprudential policy ” on work to be done in the field. davies & tracey ( 2014 ), “ too big to be efficient? the impact of implicit funding subsidies on scale economies in banking ”, journal of money, credit and banking ( forthcoming ). rajan, r. ( 2013 ), a step in the dark : unconventional monetary policy after the crisis. andrew crockett memorial lecture, bis, 23 june 2013. laeven and levine ( 2007 ), “ is there a diversification discount in financial conglomerates? ”, journal of financial economics 85 ( 2 ). bis central bankers ’ speeches of the financial sector or banks is. but at least what we can do is to remove any perverse incentives which could lead to an excessive growth of the sector and its risks. eliminating the too - big - to - fail assumption by making resolution of systemically important financial institutions a

. with the emergence of problems in the sub - prime sector, investors suddenly refrained from buying such abcp, treating it as too risky, especially as the quality of the underlying loans behind the securities purchased by the conduit was often uncertain. given the maturity mismatch between their assets and liabilities, conduits therefore started to draw on the credit lines they had originally been granted by their sponsoring banks, in particular banks resident in the euro area. this ultimately gave rise to liquidity shortages in the inter - bank money markets around the world, including in the euro area. between the end of june and early august, it became clear that a number of european financial institutions needed liquidity to provide credit to their conduits that had invested in the us sub - prime market. in the end, the demand for liquidity, in combination with a loss in confidence among banks, resulted in a hoarding of cash and the interest rate in the overnight segment of the money market in the euro area increased significantly, trading up to 70 basis points above its normal level. • recognising these tensions, the ecb reacted immediately. specifically, it undertook a special liquidity providing operation ( a so - called fine tuning operation ) on 9 august in an attempt to reduce the overnight interest rate to more normal levels more consistent with key ecb interest rates and thus the monetary policy stance decided by the governing council. • before describing in greater detail the nature of the ecb ’ s response, it is useful to explain why a response was needed. 4. why did the ecb respond? • consistent with the principle that monetary policy decisions should be kept separate from liquidity policy decisions, a distinction needs to be drawn between two elements of the ecb ’ s response. • as regards monetary policy, the ecb response was governed by the likelihood that the turmoil in financial markets would have probably some implications for the outlook for price developments and thus for the course of a monetary policy resolutely focused on the maintenance of price stability. consistent with its monetary policy strategy, the governing council conducted a comprehensive assessment of all factors that impinge upon the prospects for price stability and acted in a manner that best serves its primary objective. since a major financial event such as the august money market turmoil has the potential to change the assessment of the prospects for price stability, monetary policy had to respond. • explaining the need for a liquidity policy response is more complex. as we have seen, the