mario draghi : how to restore financial stability lecture by mr mario draghi, governor of the bank of italy and chairman of the financial stability forum, at the 5th bundesbank lecture, berlin - brandenburgische akademie der wissenschaften, berlin, 16 september 2008. * * * as this crisis hits its first anniversary, it has evolved into an even more complex combination of rising inflation, declining growth, tightening credit conditions, and widespread liquidity tensions pervading the global financial industry. banks have raised a significant amount of capital to partly offset writedowns and credit losses. but they are now moving into a phase where credit losses in the banking book will begin to rise. and banks are entering this phase with weakened balance sheets. alongside a rise in credit related losses, the outlook for bank profitability is poor. the aggregate amount of capital in the system is great enough, under reasonable scenarios, to prevent the system as a whole from falling below regulatory thresholds. but the distribution of that capital obviously matters. and, for larger banks, the capital levels demanded by the market have gone up in response to the greater uncertainty and reduced transparency about their balance sheets. we estimate that banks are likely to need to raise at least once again the amount of capital raised since the crisis began. there are various reasons why some banks will be struggling to reach those levels. that is especially the case for the banks that ran the debt - financed, highly leveraged and maturity mismatched business model that provided steady fee income over the last several years. now their profitability looks impaired, and their desired deleveraging is likely to be happening through a reduction of new lending. capital increases are especially difficult in a situation of deteriorating stock markets where falling equity prices nullify the still significant efforts undertaken to delever banks ’ balance sheets. this has spurred increasing recourse to hybrid capital instruments, but these may raise in the future concerns about the quality of the capital raised. let me finally observe that the situation of the banks in the euro area is so far better than the one we are witnessing in the us and in other jurisdictions. as the crisis unfolds policies are taking a variety of shapes that can be grouped within two broad categories : emergency and structural responses. until now, the first remained typically national since each crisis was unique to the financial structure of the country and so were the remedies. however, if the crisis were to become systemic – and the past weekend has shown just how

economy? could specific monetary policy measures adopted by the ecb weaken the transmission mechanism by negatively affecting banks ’ profits and capital accumulation and hence lower the incentives for banks to engage in lending activities? many factors are at work, and disentangling the impact of the app from that of other measures is of capital importance in informing the monetary policymakers ’ decisions. yet, it is no easy task ; and that is why solid, in - depth analysis, looking at these issues from different angles and with different tools, is surely needed. the first part of today ’ s workshop will provide several interesting papers which attempt at doing that. the second half will deal with another question that is being asked in the monetary policy debate, namely whether the current, extraordinarily expansionary monetary policy stance is inducing excessive risk - taking and thereby possibly igniting tomorrow ’ s financial crises. low interest rates and yields make investors inclined to search - for - yield and embark on riskier investment strategies. up to a point, this is not an unintended consequence of the current monetary policy measures, but actually part of the hoped - for transmission mechanism. portfolio rebalancing is a key component of the mechanism that is expected to transmit the app to the real economy. it is conceivable, however, that this may eventually go too far and the amount of risk - taking induced by the eurosystem ’ s monetary policy exceeds what is optimal and results in more costs than benefits. i do not think there is any evidence that this is happening so far at the aggregate level. there are localized tensions, particularly in the property market in certain member states ; these need to be tackled, and are being tackled, by macroprudential measures. opinions on the respective roles of monetary policy and macro prudential tools differ, as is perhaps natural given that macro - prudential policy is still in its infancy ; more research on these topics is therefore welcome. looking at today ’ s impressive collection of papers, i have no doubt that the workshop will go a long way towards providing us with answers to many of the questions i listed. i very much look forward to hearing about your findings and the outcome of your discussions. before the presentations begin, i would like to thank all those that contributed to this workshop, both from the banca d ’ italia and from other national central banks of escb or academia. i wish you all a most successful workshop, and a pleasant stay in rome and at the