and investment, and for canada. however, the conflict could worsen, jeopardizing important global value chains. this would surely reduce long - term growth and prosperity globally, although the overall implications for inflation would be uncertain. closer to home, governing council has been assessing how people are adapting to both higher interest rates and the changes to mortgage underwriting guidelines implemented earlier this year. we have seen that households are adjusting their budgets largely as expected. we understand that this can be difficult, particularly for those who are highly indebted. at the same time, employment and incomes continue to grow, which can help to cushion the adjustment process. further, the quality of new debt is improving and housing activity is moderating to a more sustainable level. all of this is making the economy more resilient, and reduces the chances of painful outcomes for many people further down the road. the rule changes also appear to have helped take the wind out of the sails of speculators in some markets, which reduces the pressure on housing affordability. overall, while financial system vulnerabilities are still elevated, the fact that they have stabilized and edged down in a number of respects is positive. there is an updated analysis of these household issues in box 4. more detail will be published about the effects of the underwriting guidelines on borrowing on the financial system hub that we will launch in a couple of weeks. the hub is designed to be a place on our website where we can post our analysis of current financial system vulnerabilities and risks in a manner that is accessible to a wide audience. given all these factors, governing council agrees that the policy interest rate will need to rise to a neutral stance in order to achieve the inflation target. you may have noticed that we have not used the word “ gradual ” to describe the pace of policy adjustments. this is to avoid the impression that we are following a preordained, mechanical policy path. the appropriate pace for interest rate increases will depend on governing council ’ s assessment at each fixed announcement date of how the outlook for inflation and related risks are evolving. in particular, governing council will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt. while the focus of many commentators tends to be on the downside risks, it is also possible that strong consumer confidence builds on solid job and income growth, and leads to greater - than - expected consumption. we will also pay close attention to

financial institutions that engaged in what economists call maturity transformation. commercial banks engage in maturity transformation when they use deposits, which are normally short term, to fund loans that are longer term. shadow banks do something similar. further, they do much more. they are the hedge funds ; they were the conduits for asset backed securities ; they were the special purpose vehicles for highly leveraged activity, with serious asset liability mismatch. 7. the financial stability board ( fsb ), an organization of financial and supervisory authorities from major economies and international financial institutions, developed a broader definition of shadow banks that includes all entities outside the regulated banking system that perform the core banking function of credit intermediation ( that is, taking money from savers and lending it to borrowers ). 8. why are they called shadow banks? because there was so little transparency, it often was unclear who owed ( or would owe later ) what to whom. most of their liabilities were off balance sheet ; so also most of their assets. as someone put it, the shadow banking entities were characterized by a lack of disclosure and information about the value of their bis central bankers ’ speeches assets ( or sometimes even what the assets were ) ; opaque governance and ownership structures ; little regulatory or supervisory oversight of the type associated with traditional banks ; virtually no loss - absorbing capital or cash for redemptions ; and a lack of access to formal liquidity support to help prevent fire sales. 9. how did they come on scene? why nobody bothered about them? that was because they did not mobilize demand deposits and did not engage in payment services. maturity transformation i. e. raising funds and indulging in lending and investment activities is a legitimate economic activity. since public funds were not to be called upon to rescue these institutions, they were not regulated. 10. however, during the financial crisis of 2007 and 08, these shadow banks received heightened attention, because of their role in precipitating the crisis. the world woke up rudely to the crisis and more specifically to the existence of shadow banks. 11. demands for regulating them attained increasing crescendo. economist paul krugman said that the shadow banking system was the core cause of the crisis. “ as the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that they were recreating the kind of financial vulnerability that made the great depression possible – and they should have responded by extending