jean - claude trichet : reflections on the global financial system keynote speech by mr jean - claude trichet, president of the european central bank, at the 2007 25th anniversary iif annual membership meeting, washington dc, 20 october 2007. * i. * * introduction it is a great pleasure to be here on the occasion of the 25th anniversary iif annual membership meeting. during the last quarter of a century, the institute has proved to be both an important coordination forum for the international financial industry and a counterpart to international financial institutions and fora, making many valuable contributions to the international dialogue on the global financial system. back in 1983 when the institute was founded – in response to the international debt crisis – one of its key jobs was to provide its members with information about the policies and performance of borrowing countries. as time passed by, the range of the institute ’ s activities broadened and it has worked as well on such issues as global financial regulation. moreover, it played an active role during the last number of years in the debate about the international financial architecture and emerging market policy issues. celebrating today ’ s anniversary brings to mind not only the many policy issues that we discussed over the past 25 years but also the many colleagues and friends from all parts of the world whose professional careers are in various ways linked to the development of the international financial system and to the issues that the institute has been dealing with. i myself have interacted with the iif on many occasions, not only back in the 1980s when i was chairman of the paris club, but also thereafter in my capacity as governor of the banque de france and today as president of the european central bank. in my talk today, i will seize the opportunity of the 25th anniversary of the institute and share with you some thoughts on two broad issues that i deem particularly relevant. first, i will recall the past financial crises that have hit emerging market countries over the last two and a half decades and focus on the progress that has been achieved with regard to devising mechanisms for crisis prevention and crisis containment. second, i will take a closer look at the recent turmoil in financial markets and provide some preliminary reflections. ii. emerging market countries and their access to international financial markets the financial integration of countries into the global economy continues at a high pace. while advanced countries are the most financially integrated, emerging market countries have significantly increased their cross border asset and liabilities positions and hence improve their degree of integration. the tremendous benefits that are associated with this integration process

are us sub - prime mortgages and it quickly spread, causing disruptions in the asset - backed commercial paper ( abcp ) market and eventually, by way of consequence, in the unsecured inter - bank money markets as concerns mounted about counterparty credit risks. several markets were affected by the turbulence and the spill - over effects were generally characterised by losses of market liquidity and heightened market volatility. it is important to note that the present significant market correction is not an event that should surprise us. we had been quite clear, since a number of months if not years in stressing a global phenomenon of underpricing of risks which was signaled in particular by a low level of volatility, a low level of spreads, a low level of risk premia across the board in a large array of products and markets. in many respect the present episode can be interpreted as correcting those anomalies and paving the way – once the turbulences would have dissipated – for a more sustainable structure of global finance. that being said even if the likelihood and even the necessity of a market correction was largely recognised by the public as well as the private sector, the channels that were the vehicles for the propagation of the turbulences were not identified ex ante. several observations can be made in this respect. first, despite the fact that over recent years credit risk transfer has facilitated a widespread sharing of risk in the financial system, the recent market turbulence has nevertheless confirmed pre - existing concerns about the risks stemming from a lack of transparency about where credit risks ultimately reside in the financial system. paradoxically in a large number of cases the credit risk remained in the realm of the commercial banks through the commitment they still had to activate back up lines of conduits or structured investment vehicles. second, even if the risks were well dispersed across the system, the recent events have illustrated the importance of adverse selection problems in a crisis situation in that even a suspicion that counterparties could have modest exposures to assets for which no market value can be computed can significantly impair market functioning. third, the financial market turmoil has highlighted vulnerabilities created by off - balance sheet special investment vehicles set up mostly by banks. such vehicles have proven to be more prone to liquidity mismatches than anticipated, which, as a result, caused contingent credit lines to be drawn on banks. finally, the fact that the problems were related to the rolling over of secured short - term financing instruments rather than unsecured