extension and potential effect of any reallocation of bank sovereign exposures across banks ; the interactions with other rules of the basel framework, including in particular the rules on liquidity ; the impact of changes in regulation on the provision of loans to the broader economy ; the consequences for monetary policy ; the effects on the functioning of sovereign debt markets and on governments ’ financing conditions ; the impact on other financial market segments. several of these issues are being investigated at the bis and also at the eu level, within the european systemic risk board and the economic and financial committee. the impact on market liquidity has been examined in this conference. changes in the current prudential framework leading to stricter capital requirements on sovereign bonds could incentivise banks to further reduce the two pillars of market - making : sovereign bond inventories and repo activities, which are eroding liquidity in secondary markets. the effects of a regulatory change requiring substantive bank recapitalisations could be destabilising in the transition phase, as it would entail a temporary but negative impact on credit to the economy – an important effect, in the presence of stubbornly low nominal growth and deflation risk. such an effect is hard to capture analytically, as non - linearities are possible, especially in the presence of financial tensions, and multiple equilibria cannot be excluded. envisaging a long transition period is unlikely to help, as market participants will probably respond immediately by front - loading future changes in regulation, in order to exploit “ first mover ” advantages. ratings have important drawbacks, but practical alternatives are hard to find. if the decision is eventually taken to adopt risk weights on sovereign exposures, mechanisms based on fiscal sustainability indicators, such as those computed by the eu commission or by the imf could be considered as an alternative to – or in a suitable combination with – credit ratings. 12 to conclude, the debate on changing the prudential regulation of sovereign exposures was prompted by the recognition that “ sovereign debt is not risk - free ”. there is no doubt that this is true. however, at the current stage a broad agreement has been reached on the pros and cons of different reform options, not on their overall balance. my personal view is that the potential benefits of a reform are uncertain, while the potential costs could be sizeable. be that as it may, as long as such a balance remains uncertain, a prudent stance would be to wait for

issues that merit separate consideration. i will turn now to financial risks. the most important of these is credit risk, which turkish banks pay the most attention to managing. the turkish banking sector has become used to accepting and managing credit risk over the years. a credit culture has been developed in which firms, sectors, regions and individuals participate. increased competition in the sector clearly has implications for the risk - taking process, which requires that the banks restudy their credit strategy. an overall examination of credit risk showed that the banking sector has been able to manage its credit risks by keeping the level of non - performing loans low in spite of an environment of shrinking international financing. as to liquidity risk, the fact that depositors prefer shorter terms, while investors, driven by expectations of high inflation and uncertainty, prefer longer terms, has caused a mismatching of the maturity structures of the assets and liabilities of the banking sector. as a result, banks become more vulnerable to liquidity risk. financial distress and global financial crisis were the main ingredients of the conjuncture of 1998. following scattered failures in the emerging financial environment, almost all emerging economies began to be treated as risky, due to growing uncertainty about the near - term outlook for the financial markets. in this situation, international investors became more cautious about investing in the emerging markets and became reluctant to provide them with credit. turkish banks slowed their disbursements of credit, preferring to be liquid in the marketplace. we also checked using different ratios for the liquidity in the system. interest rate risk is another important form of systemic risk. since the maturity structure of interest - sensitive liabilities in the turkish banking system tends to favor the relatively shorter maturity segments, external funds are repriced at shorter intervals than assets. this mismatch in the pricing structure at various periods increases the sensitivity of assets and liabilities to changes in interest rates. banks manage the degree of interest rate risk to which they are exposed during times of rising interest rates by converting their low interest bearing securities into high interest bearing securities by means of repurchase transactions. interest rate swaps and some other derivative instruments are also used to hedge interest rate risk. as to foreign exchange risk, the difference between the turkish lira interest rate and the nominal depreciation of the turkish lira is the major reason why the banks place foreign currency funds in turkish lira funds or other alternative investment opportunities. in turkey ’ s case, the practice of taking short positions for foreign exchange started