vol. 31 ( august, part 2 ), pp. 596 - 618. calculated from nasd, trace corporate bond data. calculated from nasd, trace corporate bond data. reuters loan pricing corporation, www. loanpricing. com / analytics / pricing _ service _ volume1. htm. reduce or to take on more credit risk. in contrast, for corporate bonds, the lack of a well - developed securities lending market makes it difficult to shed credit risk by short selling. the enhanced transparency and liquidity of credit markets and the development of new instruments for customizing the risk characteristics of credit exposures have resulted in a wider dispersion of credit risk. although significant participation by nonbank institutional investors has long been a hallmark of u. s. credit markets, these developments have facilitated greater risk - bearing by entities other than banks and other highly regulated depository institutions. on its face, a wider dispersion of credit risk would seem to enhance the stability of the financial system by reducing the likelihood that credit defaults will weaken any one financial institution or class of financial institutions. some have expressed concern about the transfer of risk by banks and other heavily regulated depository institutions to more lightly regulated or unregulated entities. some specific concerns are quite legitimate. for example, as i will discuss in a few moments, if banks transfer credit risk to other entities through mechanisms that expose the banks to counterparty risks to those entities, the transfer is fully effective only if the banks manage those counterparty risks prudently. however, some other concerns about the transfer of credit risk outside the banking system seem to be based on questionable assumptions. for example, some observers believe that credit risks will be managed more effectively by banks because they generally are more heavily regulated than the entities to which they are transferring credit risk. but those unregulated or less regulated entities should in principle be subject to more - effective market discipline than banks because, without a safety net supporting them, their creditors have stronger incentives to monitor and limit their risk - taking. in fact, while many focus on the dangers of risk transfer to highly leveraged entities that might be vulnerable to a sharp widening of credit spreads, a significant portion of the risks that are being transferred outside the banking system are being transferred to institutional investors that are far less leveraged than banks. challenges associated with recent developments the benefits from the development of new instruments and markets that i have described will be fully realized only if market participants address various risk

u. s. government securities with the federal reserve bank of new york. the criteria that it will apply in determining the eligibility of money market mutual funds to serve as counterparties in reverse repurchase agreements. as an additional means of draining reserves, the federal reserve is also developing plans to offer to depository institutions term deposits, which are roughly analogous to certificates of deposit that the institutions offer to their customers. a proposal describing a term deposit facility was recently published in the federal register, and the federal reserve is finalizing a revised proposal in light of the public comments that have been received. after a revised proposal is reviewed by the board, we expect to be able to conduct test transactions this spring and to have the facility available if necessary thereafter. the use of reverse repos and the deposit facility would together allow the federal reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly, should it choose to do so. when these tools are used to drain reserves from the banking system, they do so by replacing bank reserves with other liabilities ; the asset side and the overall size of the federal reserve ’ s balance sheet remain unchanged. if necessary, as a means of applying monetary restraint, the federal reserve also has the option of redeeming or selling securities. the redemption or sale of securities would have the effect of reducing the size of the federal reserve ’ s balance sheet as well as further reducing the quantity of reserves in the banking system. restoring the size and composition of the balance sheet to a more normal configuration is a longer - term objective of our policies. in any case, the sequencing of steps and the combination of tools that the federal reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments and on our best judgments about how to meet the federal reserve ’ s dual mandate of maximum employment and price stability. in sum, in response to severe threats to our economy, the federal reserve created a series of special lending facilities to stabilize the financial system and encourage the resumption of private credit flows to american families and businesses. as market conditions and the economic outlook have improved, these programs have been terminated or are being phased out. the federal reserve also promoted economic recovery through sharp reductions in its target for the federal funds rate and through large - scale purchases of securities. the economy continues to require the support of accommodative monetary policies. however, we have been working to ensure that we have the tools to