this is not just a vulnerability of firms. markets too can suffer a self - fulfilling evaporation of liquidity. a central element of the recent crisis was, indeed, the drying up of liquidity in the abs markets and the money markets. as liquidity premia soared, many asset values collapsed, and the net worth of many traders and banks was eroded. this was a vicious circle, because the liquidity of many financial markets depends on short - term traders being ready and able to trade, since end - buyers and sellers will not always want to transact at the same time. those traders often depend, in turn, on maintaining access to financing from banks. everyone has been reminded, therefore, that the liquidity of markets and the well - being of leveraged, maturity - mismatched firms are inextricably intertwined. our capital markets and much of the “ plumbing ” of the financial system – notably the payments system – rely on confidence in the integrity of the assets being traded, in the robustness of counterparties, in the reliability of infrastructure. crises nearly always involve that confidence sliding away. so, although financial systems look solid most of the time, they can in fact prove brittle. their degree of vulnerability or resilience depends, amongst other things, on the leverage and the liquidity mismatch in the system as a whole. that entails thinking of the system in aggregate ( effectively netting out intra - system exposures ), in terms of its position vis a vis borrowers and savers in the rest of the economy. and it means thinking of the system distributionally ( ie gross ), meaning the network of exposures amongst firms and taking into account the weakest links in the chain. pulling those various strands together, a definition of financial stability that has informed my own contributions to the reform debate is the following : “ financial stability prevails where the financial system is sufficiently resilient that worries about bad states of the world do not affect confidence in the ability of the system to deliver its core services to the rest of the economy. ” the key words are “ confidence ” and “ resilience ”. “ bad states of the world ” obviously include recessions ; and other jolts from the real economy, due to the accumulation of too much debt within or between countries. macro imbalances do not invariably lead to instability in the financial system, but they do often extend the chain of intermediation between savers and investors

real economy and to traders in financial markets. firms of all kinds are able to economise on the stock of liquid assets they would otherwise need to hold. 3 but banks can provide those liquidity - insurance services only if depositors are confident that they can convert their deposits into cash ( central bank money ). that does not mean that every bank must be completely safe, but it does mean that the resolution regime must be equipped to preserve their core monetary services whether by resurrection or the transfer of transactions - deposits to a healthy competitor. in talking about banks, i must stress that it is the economic substance that matters, not the legal form. we must also take care with the resilience of “ shadow banking ” firms and structures characterised by liquidity transformation and leverage. 4 and we must take account of the network of exposures and behavioural influences of funds, long - term institutions, brokers etc. they are all connected by markets. i find it is helpful to distinguish between those markets whose role is to provide essential support to banking and insurance, and those markets that directly deliver the financial system ’ s core functions to the rest of the economy. for example, the overnight wholesale money markets are vitally important, because banking could not operate without them. they are effectively part of the payments system infrastructure, and have long been of concern to central banks. the financing markets, notably repo, fall into the same broad category, although the authorities could have been closer to the securities lending markets over the past decade. there is a lesson in that. some other markets, typically in the past more distant from the attention of the financial stability authorities, may matter in their own right to end users. that is especially relevant where a significant proportion of the intermediation of savings / investment occurs via capital markets rather than via bank balance sheets. in the usa at least, some securitisation markets probably pass that test. in the uk, i would guess that the equity and corporate bond markets do so. the integrity of those core capital markets is vital. such markets must be resilient to shocks. otherwise disruptions could materially impair the supply of credit ( and equity ) to the economy, with macroeconomic and other welfare costs. when the securitisation markets closed in the usa, it was not realistic for that part of the credit system to be reintermediated by the banking system in short order. the essential ingredients of a resilient market include a robust