to disseminate this to investors and other interested parties on a regular basis. see “ summary of european industry commitments to the european commission regarding transparency in the european securitisation market ” ( www. europeansecuritisation. com / industry - letter - 08feb08. pdf ). the institute of international finance ( iif ) also has an active agenda of work, covering risk management, liquidity, valuation, ratings, and transparency. ( see http : / / www. iif. com / press / press + releases + 2007 / press + 46. php ). rating agencies to expand their scope as widely as possible, and for banks to use off - balance - sheet vehicles ; and • improving crisis management arrangements, including the process for providing liquidity to institutions under stress and for restructuring weak and failing banks. measuring and adjusting for risk the focus of this work is the recent structural changes in banking and credit markets and ways to prevent those making the financial system more prone or less resilient to large cyclical swings. that is important. but we have been here before. it is not so long since a vast amount of work was set in train in the wake of the ltcm crisis in 1998 and again after the dotcom boom blew out. while each crisis has its own idiosyncrasies there are common elements and they too need to be addressed. in my view the key lies in the measurement of risk and the repeated inclination to underprice risks at the top of the cycle and thus take comfort from exaggerated estimates of risk adjusted returns ; and the corollary, a tendency to overprice risk as the cycle swings down. at the macro level it is hard to assess what is a warranted rise in asset prices and what an unsustainable boom ; in regulation it has proved hard to design systems which adjust appropriately for the cycle, never mind which effectively lean against it ; and at the micro level firms find it difficult to measure the risks in their strategies and to base their targets and incentive systems on risk adjusted returns. we must try to align incentives between actual risk and return by improving risk management practices ( for example on off - balance sheet activities ) and rectifying the revealed weaknesses in the originate - to - distribute model whether in the us mortgage market, in valuation practices or in the use of rating agencies. but we know that many of the incentive problems are deeply embedded – after all, asymmetry is inherent in

john gieve : the return of the credit cycle – old lessons in new markets speech by sir john gieve, deputy governor of the bank of england, at the euromoney bond investors congress, london, 27 february 2008. the original speech, which contains various links to the documents mentioned, can be found on the bank of england ’ s website. * * * introduction the turmoil in credit markets since august has been novel in some ways ; but in others, the longer it has gone on the more familiar it has seemed. it has been looking less and less like the crystallisation of a “ tail ” risk – the “ unprecedented and unforeseeable ” event described by northern rock directors – and more and more like the unwinding of a wider credit boom during which risk premia had become unsustainably compressed. the excesses may have been most obvious in the complexities of structured credit and the sub - prime sector but they have not been confined to them. as in previous banking cycles, a period of strong growth, low interest rates and rapid increases in asset prices lead to over confidence and bad lending at the top of the cycle ; defaults, deleveraging and retrenchment follow in the downswing. but the way this old story has unfolded through the new credit markets has sprung some unpleasant surprises, including the speed with which losses in just one market in one country – the housing market in the us – have disrupted wider credit markets in all advanced economies. the upswing – a new structure of banking the roots of the problem lay in the so - called “ great stability ” of steady growth and inflation and in particular the last five years of persistently low nominal interest rates. the confidence born of that stability was combined with an increased institutional demand for fixed income and heightened international competition among the largest banks to develop scale. that led to a remarkable decline in corporate investment yields which was matched, and for a while seemed justified, by declining volatility ( see chart 1 which shows the fall the spreads and volatility of high yield bonds ). 1 and it put pressure on investors to find new ways of generating returns from credit. at the same time advances in it and financial modelling allowed the development of new derivatives, and the slicing, dicing and recombining of credits in new structured credit instruments. the search for yield would have made the us sub - prime mortgage market attractive to many investors. what made it irresistible was the financial engineering that