frederic s mishkin : systemic risk and the international lender of last resort remarks by mr frederic s mishkin, member of the board of governors of the us federal reserve system, at the tenth annual international banking conference, federal reserve bank of chicago, chicago, 28 september 2007. the original speech, which contains various links to the documents mentioned, can be found on the us federal reserve system ’ s website. * * * after the calm of the past several years, the events of this summer are a strong reminder that our increasingly globalized and sophisticated markets are still vulnerable to systemic risk. when we speak of systemic risk, we mean the risk of a sudden, usually unexpected, disruption of information flows in financial markets that prevents them from channeling funds to those who have the most productive profit opportunities. we have seen how systemic risk, when it becomes especially severe, can result in financial crises – the seizing up of financial markets – which can have potentially important economic consequences. we have also seen how governments, in their role as providers of emergency liquidity, can intervene to help put the financial system back on its feet and prevent a financial crisis from spinning out of control. 1 in mature industrial economies, domestic central banks have the credibility and the resources to play this role. around the world, central banks have injected liquidity and signaled that credit would be available to those institutions and markets that need it. at other times, as well, the federal reserve has acted successfully to prevent potentially devastating financial seizures : notably, after the stock market crash of october 19, 1987, and after the terrorist attacks of september 11, 2001. given the current focus on systemic risk, i would like to talk about an issue that i wrote about extensively before coming to the board of governors : financial instability in emerging - market countries. ( please note that my comments here reflect my own views and not necessarily those of the board of governors or the federal reserve system. ) the need for emergency liquidity assistance in times of financial instability is just as strong, and arguably stronger, in emerging - market countries, in part because their less - developed financial markets, weaker institutions, and lack of easily available information often make these countries especially vulnerable to systemic risk. such risk can be elevated and financial instability triggered by several factors : shocks related to weak domestic institutions and policies, swings in world commodity prices, contagion from other emerging markets, and, turmoil originating in the industrial countries. 2 developing economies have made great strides over the

the firms can regain access to the credit markets. crucial to a country's successful resolution of a financial crisis is a commitment to necessary reforms and a refusal to go halfway. allowing weak financial institutions or practices to continue may encourage excessive risk - taking because participants have little to lose. because the continued presence of excessive risk diminishes confidence in the future health of the financial system, insolvent financial institutions must be shut down. limit moral hazard by encouraging adequate prudential supervision the funds provided by lenders of last resort may be used indirectly to protect depositors and other creditors of banking institutions from losses. this safety net means that depositors and other creditors have little incentive to monitor these banking institutions and withdraw their deposits if the institutions are taking on too much risk. as a result, in the absence of a strong system of bank supervision, banking institutions are encouraged to take on exposures that heighten systemic risk. to limit the moral hazard problem created by their acting as lenders of last resort, governments and institutions must make improved financial - sector supervision and regulation a high priority. the usual elements of a well - functioning prudential regulatory and supervisory system are adequate disclosure and capital requirements, limits on currency frederic s. mishkin, " asymmetric information and financial crises : a historical perspective, " in r. glenn hubbard, ed., financial markets and financial crises ( chicago : university of chicago press, 1991 ), 69 - 108. mismatch and connected lending, prompt corrective action, careful monitoring of an institution's risk - management procedures, close supervision of financial institutions to enforce compliance with regulations, and sufficient resources and accountability for supervisors. often, however, strong political forces resist putting these kinds of measures into place. this resistance has been a problem in industrialized countries ( it was, for example, an important factor in the u. s. savings and loan debacle of the 1980s ), 4 but the problem is far worse in many emerging - market countries. the political will to adequately regulate and supervise financial institutions can be weak because powerful special interests have prevented such oversight and because the underlying legal and political framework has often been too frail to counteract the special interests. another important element of financial regulation is that the owners, if not also the managers, of insolvent institutions should suffer significant losses in the event of insolvency. in emerging - market countries ( and sometimes in advanced countries, a prominent example of which is japan during the