need for european financial institutions to make a substantial capital enhancement based on its estimate of potential losses of 200 billion euros that european financial institutions could suffer in the event of a collapse in the prices of government bonds of peripheral countries such as greece. however, given the current weakness in stock markets, it is not easy for financial institutions to increase capital on their own. as a result, concerns about counterparty risk have increased, causing some financial institutions to reduce interbank market trading activities. in addition, uncollateralized interbank trading, particularly of term instruments, has been declining, leading to an increase in funding costs for european financial institutions, mainly for longer - term and u. s. dollardenominated funds. in a comprehensive set of additional measures agreed at the end of october, the eu decided to require european financial institutions to attain a core tier 1 capital ratio of 9 percent by end - june 2012, after accounting for market valuation of sovereign debt exposures. it was also decided that when financial institutions are unable to increase capital by themselves, national governments should provide support or, if they are unable to do so, the efsf should do so. it would have been easier to come up with a solution if the problem had been contained to fiscal deficits, as was the case for greece at the beginning. the appropriate response would leverage here refers to, for example, “ guarantees ” to be provided by the efsf, which could amount to many times over what the facility can directly lend. if approved, the efsf could be given more flexibility over the measure to prevent a crisis from spreading to major euro area member states. in addition, it has already been decided to make the efsf a permanent institution and set up in mid - 2013 the european stability mechanism ( esm ) with the aim of facilitating a smooth restructuring of government debt issued by countries in financial difficulties. it has also been reported that discussions are underway to bring forward the starting date of the esm by a year. bis central bankers ’ speeches have been to increase government revenue and reduce expenditure in the short term, while pushing through a wide range of economic reforms in the medium to long term aiming to achieve sustainable growth. however, when it comes to measures to stabilize the financial system, things become much more difficult, because the impact on international financial markets cannot be ignored. a major factor currently destabilizing international markets lies in the daunting situation of having to deal with two crucial issues simultaneously

exporting economies on the basis of the perception that it is a relatively safe international currency. moreover, in some emerging economies, cross - border capital flows have reversed, leading to a decline in stock and bond prices as well as foreign exchange rates. the main reason that instability in international financial markets has increased is a lack of confidence in measures undertaken by the eu to resolve the fiscal and financial problems in europe. as i will explain in the next section, the problems in europe are unlikely to be resolved in the short term. therefore, international financial markets are expected to face continued strains for a while. ii. the fiscal and financial problems in europe so far, i have presented an overview of the outlook for global economic and financial developments. now, i would like to take a closer look at the fiscal and financial problems in europe, which have become the epicenter of the growing strains in international financial markets. 1 before i go into details, i would first like to make sure that the difference between the eu and the euro area is well understood. the eu is an economic partnership between 27 countries and constitutes the world ’ s largest economic zone. it has a population of about 500 million and accounts for more than 20 percent of global gdp. people and money can move without restrictions in the region. the euro area, on the other hand, is presently comprised of the 17 eu member states that have adopted the single currency called the euro. countries with large economies, such as germany, france, italy, and spain, are among the members of the euro area. the area has a population of about 330 million and accounts for about 15 percent of global gdp. it is an economic zone almost as large as the united states. i will follow the standard practice of distinguishing between “ core countries ” ( such as germany, france, the netherlands, and belgium ) and “ peripheral countries ” ( such as greece, ireland, portugal, spain, and italy ). this speech is based on information available as of october 31, 2011. bis central bankers ’ speeches a. the three problems faced by the euro area the fiscal problems in the euro area have now reached a critical stage. looking back, the fiscal problems of greece surfaced in spring 2010, followed by those of ireland in fall 2010 and portugal in early 2011. as these countries – with large fiscal deficits and / or government debts – faced a sharp increase in the cost of funding, they had no choice but to ask the eu and the imf to provide them with