##ctuate, they are set in currency markets according to the demands and supplies of forward - looking traders, and they can be very volatile, often overshooting long - term values. this volatility can destabilize trade and impart significant uncertainty to international lending. borrowers may borrow in international markets expecting to repay at one exchange rate, and when the bill comes due, the exchange rate may differ, by a lot. lenders and borrowers can both hedge, but hedging is costly, and institutions providing this hedge can go broke. • financial institutions. financial institutions engage in what is known as maturity transformation. they take deposits from you and me, which deposits can be redeemed any time we take out our check book, and make long - term loans to mortgage borrowers and businesses. there are fantastic efficiencies in this process - consumers can get higher returns on their saving, and business can borrow and invest in productive equipment. indeed, banks and other financial institutions play the same role in allocating domestic saving to its best uses that the international capital market plays for international capital. but as with capital flows, there are risks. if the banks ’ loans go bad, the institution is in trouble and may not be able to redeem deposits. within a country ’ s borders there are often institutions such as deposit insurance to protect savers, but internationally the risks can be greater. given that banks are involved in the domestic saving, investment process, it is not surprising that they have become heavily involved in the international saving, investment process. in general this process too has led to worldwide efficiencies, but here too there are risks. in japan, for example, the banks have been hurt by a massive decline in real estate and other values, which have put many nonperforming loans on their books. in korea and indonesia, the banks were hurt by the foreign currency exposure of their borrowers. • incentive effects. incentive effects are always important in economics, generally complicating the analysis of policy measures. nowhere is this as true as with international capital flows. one incentive problem involves what is known as moral hazard. suppose national governments do intervene to protect the safety and soundness of banks. that intervention might seem sensible, but it could inspire more risky lending by the banks, to let the government pick up the tab if things go bad. a second problem involves unilateral default on loan payments or currency obligations. defaults would

seniorfinancial - officer - survey - 202309. pdf ; board of governors of the federal reserve system ( 2023 ), senior financial officer survey results ( washington : board of governors, may ), https : / / www. federalreserve. gov / data / sfos / files / senior - financial - officer - survey - 202305. pdf. see board of governors of the federal reserve system ( 2022 ), “ fomc communications related to policy normalization, ” webpage, https : / / www. federalreserve. gov / monetarypolicy / policynormalization. htm. note that the original statement was in january 2019 ; see board of governors of the federal reserve system ( 2019 ), “ statement regarding monetary policy implementation and balance sheet normalization, ” press release, january 30, https : / / www. federalreserve. gov / newsevents / pressreleases / monetary20190130c. htm. both the standing repo facility and the fima repo facility were established in july 2021 ; see board of governors of the federal reserve system ( 2021 ), “ statement regarding repurchase agreement - 9pleased to see that there has been a steady growth in the number of firms signed up for the facility, and that current bank counterparties to the facility engage in regular testing as a part of maintaining access. despite these improvements in our tools, it is also important to closely monitor market conditions well before pressures emerge. there are a variety of market indicators that we can track closely to assess whether banks are beginning to have difficulty accessing reserves in a way that could affect the constellation of short - term rates. we are also watching for signs of frictions in the redistribution of reserves that may not be immediately evident in wholesale funding markets. these frictions could result from a variety of factors including the fact that smaller banks generally have a less diverse array of wholesale market funding options to tap when they need to bolster reserve positions. so we will be approaching these questions carefully. the committee is planning to begin in - depth discussions of balance sheet issues soon. in conclusion, i hope my remarks have given you a sense of how i view the current state of the economy as well as the path that has gotten us here. economic healing is helping us to lower inflation while growth remains solid. that is to the great benefit of the american people. the banking sector is sound,