another tool for telling stories about the future is stress testing. stress testing can thus be a very valuable and effective tool in restoring confidence. however, this requires that the stress tests are both credible and adequately disclosed. the fed ’ s stress tests of us banks earlier this year present a good example of how this tool can be used. we – at the riksbank – have been publishing stress tests of individual banks since 2006. with a track record of reasonable stress tests, the credibility of the methodology and the results has continued to increase during the crisis. building confidence in the long - run : liquidity and capital regulation the financial crisis of the past two years has been very costly. we must ensure that this crisis does not repeat itself. lawmakers, central banks and financial regulators have a daunting task ahead of them. regulatory and supervisory reform is needed. i have great hope that we will take this opportunity to create a safer and sounder financial system. in this respect, i would like to bring up two important issues for a safer financial system : liquidity and capital regulation. liquidity or, rather, illiquidity has been in the centre of this crisis. banks will always be exposed to liquidity risk due to the maturity mismatch, as this is a central feature of banking. however, in the run up to the crisis, this maturity mismatch increased too much. banks relied on the misguided perception that short - term financing would be available from liquid markets. a key lesson from the crisis is that a liquid market can very quickly become illiquid. the conclusion is that liquidity must be regulated more firmly. banks need to hold a buffer of liquid assets large enough to allow them to weather a liquidity shock. however, the definition of this liquidity buffer, as well as what type of assets should be viewed as liquid, requires careful thought. we should keep in mind the lesson that market liquidity can vanish quickly and be extremely cautious about what securities we consider to be liquid. furthermore, the power to dictate the type of assets a bank must hold will have an impact on asset markets. we must ensure that this power is not misused. from a central banker ’ s perspective, the content of the liquidity buffer has a bearing on the central bank ’ s policy on what assets to accept as collateral. in a crisis, it is the central bank ’ s decision on which securities to accept that defines liquid and illiquid assets

– at least in the local currency. therefore, the interplay of liquidity regulation and the central banks ’ collateral requirements also warrants considerable reflection. finally, liquidity regulation will make maturity transformation more costly. we clearly need more regulation today but, in casting additional regulation, we have to consider the costs. too strict regulation would stifle competition, make financial services more expensive and, in the long run, hamper economic growth. on the other hand, too loose regulation would inspire speculation with taxpayers ’ money and also reduce economic growth. thus, the extent of financial regulation is – at least partly – a question of society ’ s risk tolerance. liquidity buffers will create a cushion. however, the root of a liquidity crunch is a lack of confidence. a major aim of regulatory reform should thus be to ensure that trust does not dissipate so rapidly and completely again. in order to do this, we need to increase capital requirements, both in terms of the quality of capital and the amount of capital. after all, capital provides protection against bad outcomes. increasing the quality and amount of capital will increase the resilience of individual banks. in addition, strengthening the ability of banks to absorb losses mitigates the risk of contagion – therefore more and better capital will also strengthen the resilience of the system. in my view, the important part of capital is loss - absorbing common equity. in addition, other forms of capital are needed to protect the state. if a bank defaults, capital typically evaporates very quickly. i have seen many examples of banks that have defaulted because they did not meet the capital adequacy rules. in my experience, when bank managers say that they have a problem, they often claim to have – say – 6 per cent regulatory capital, rather than the required 8 per cent. when the authorities eventually and realistically assess the assets, capital is often negative and the state has to bail out the bank. thus, capital should be of good quality to protect the bank on a going concern basis, but also to protect the state in the event of a default. as some banks may be too big to fail, as regulators we should also discuss the possibilities of creating debt instruments which automatically convert to equity when losses mount above certain trigger points. building trust to enhance cross - border crisis management a financial crisis is costly to resolve. the potential costs are so large that only the nation state, through its power to tax, can