financial stability by central banks. forces affecting financial stability the basic forces affecting financial stability are the quickening pace of technological innovation and the growing acceptance of market processes as basic determinant of resource allocation. due to sectoral distinctions getting blurred, financial intermediaries have the ability to effectively compete in sectors beyond their domain by deconstructing and recombining risks. further, the source of financial disturbances has become more unpredictable mainly due to integration of financial markets. financial liberalisation has led to the emergence of financial conglomerates, cutting across not only various financial sectors such as banking and insurance, but also a number of countries. therefore, a contagion means the problems of distant economies can become problems of our own. the progressive opening up of the economies to external flows since 1990s has led to massive cross - border capital flows and volatile exchange rates. sharp movements in exchange rates can have an adverse impact upon the balance sheets of both financial and non - financial entities. this is especially true for emerging economies as they usually need to resort to borrowing in foreign currencies. if we recall the banking crisis and the resultant financial crisis of latin america ( imf 2004 ), we can broadly categorise the trigger points as : • a boom in credit to the private sector, for both investment and consumption ( mexico, 1994 ; and colombia, 1999 ). a particular form of boom and bust cycle is generated by the end of hyperinflationary episodes ( bolivia, 1986 ) ; • wholesale liberalization in the absence of an appropriate and effective prudential regulatory framework ( mexico, 1994 ; and chile, 1984 ). it is worth stressing, however, that highly regulated systems have also suffered crises ( peru, 1987 ) ; • direct effects of fiscal difficulties on the domestic banking system, a factor that seems to have become an increasingly important source of strain on latin american banks ( argentina, 2001 ) ; • contagion and spillovers, where a crisis in one country induces economic agents to reassess their expectations and thus reduce investment in other countries ( argentina, 1995 ), or where a crisis in one country has a direct effect on economic conditions in another country ( uruguay, 2001 ) ; • terms of trade shocks and movements in real exchange rates ( venezuela, 1994 ; and ecuador, 1998 ) ; and • political instability, unrest, and, in some cases, civil conflict. deficiencies in the following areas have detracted from good banking practices and increased vulnerability to

crisis economic growth in countries with bank - based systems lags behind that of countries with more balanced financial systems. 3 the clear policy message is that it is better to finance the real economy through several channels rather than to rely on just one. capital markets in particular can act as a useful “ spare tyre ”. 4 that is why the esrb fully supports the capital markets union, which aims to remove barriers to the development of capital markets. removing these barriers will foster changes in the structure of the financial system in europe. in fact, capital markets and other non - bank sources of external finance have been growing relative to banks. 5 this growth should improve firms ’ access to funding, and ensure that any losses are dispersed more widely. low bank profitability the overbanking in europe, highlighted in the asc ’ s report, is also a factor in the currently low 1 / 4 bis central banker's speeches level of bank profitability. a number of reasons have been mooted as the causes of this low profitability, including low interest rates. long - term real interest rates have been falling in the major advanced economies for two decades. technological change, demographics, income inequality and safe asset scarcity are just a few of the factors exerting downward pressure on long - term real rates. 6 accommodative monetary policy by the european central bank and other major central banks, acting in accordance with their price stability mandates, has also contributed to low interest rates. low interest rates tend to squeeze net interest margins owing to downward rigidity in banks ’ deposit rates. 7 but overbanking is also a factor in the current low level of bank profitability. overcapacity in some national banking sectors, and the ensuing intensity of competition, exacerbates this squeeze on margins. such over - capacity also means the sector does not operate at the efficient frontier, which is one reason why cost - to - income ratios remain high in some countries. at the same time, banks benefit from revaluations in their fixed income portfolios. moreover, profitability is boosted by a greater flow of lending and lower loan loss provisions than would have occurred in the absence of accommodative monetary policy. analysis by the ecb suggests that these effects tend to outweigh the impact on net interest income over the short term, but the picture varies depending on banks ’ business models. 8 in the broader context of generalised overcapacity and technological innovation, some banks