largest banks submit living wills that describe how they could be resolved under bankruptcy. 12 and the federal reserve has mandated that systemically important banks meet total loss - absorbing capacity requirements, which require these firms to maintain long - term debt adequate to absorb losses and recapitalize the firm in resolution. these enhancements in resolvability protect financial stability and help ensure that the shareholders and creditors of failing firms bear losses. moreover, these steps promote market discipline, as creditors — knowing full well that they will bear losses in the event of distress — demand prudent risk - taking, thereby limiting the problem of too - big - to - fail. financial stability risks can also grow large outside the regulated banking sector, as amply demonstrated by the events of 2007 and 2008. in response, a number of regulatory changes affecting what is commonly referred to as the shadow banking sector have been instituted. a specific example of such risks, illustrative of broader developments, was the buildup of large counterparty exposures through derivatives between market participants and aig that were both inappropriately risk - managed and opaque. to mitigate the potential for such risks to arise again, new standards require central clearing of standardized over - the - counter derivatives, enhanced reporting requirements for all derivatives, and higher capital as well as margin requirements for noncentrally cleared derivatives transactions. 13 another important step was the congress ’ s creation of the financial stability oversight council ( fsoc ). the council is responsible for identifying risks to financial stability and for designating those financial institutions that are systemically important and thus subject to prudential regulation by the federal reserve. both of these responsibilities are important to help guard against the risk that vulnerabilities outside the existing regulatory perimeter grow to levels that jeopardize financial stability. 14 the financial system is safer the evidence shows that reforms since the crisis have made the financial system substantially safer. loss - absorbing capacity among the largest banks is significantly higher, with tier 1 common equity capital more than doubling from early 2009 to now. 15 the annual stress - testing exercises in recent years have led to improvements in the capital positions and riskmanagement processes among participating banks. large banks have cut their reliance on short - term wholesale funding essentially in half and hold significantly more high - quality, liquid assets. assets under management at prime institutional money market funds that proved susceptible to runs in the crisis have decreased substantially. and the ability of regulators to resolve a large institution has improved, reflecting both new

public expenditure in total national income and enhancing the quality of public finances should receive greater attention. over the past decade, structural reforms in product and labour markets have paid off, contributing to a strong and steady increase in employment in the euro area. lower taxes on labour, greater labour market flexibility and increased product market competition have supported job creation and potential output growth. further progress with structural reforms, economic integration and cross - border competition are needed to address some countries ’ diverging competitiveness positions and support the smooth functioning of the euro area economy. financial stability and supervision since last summer, the global financial system has been undergoing a process of risk repricing and balance - sheet deleveraging. this process, which is still ongoing, did not come as a total surprise to us. indeed, the ecb, in particular in its financial stability review, as well as other central banks and international institutions, had issued repeated warnings about the potential underpricing of risks in a number of markets, including the us sub - prime mortgage markets. for instance, in my speech before this committee last year, i noted that the unabated growth in the volume and complexity of new financial instruments could have made these markets vulnerable to disruptive adjustments, as it was not always clear where the risk exposures ultimately lay. but although we had pointed to the risks associated with the accumulation of imbalances and had identified several vulnerabilities in the financial system, it was difficult to foresee the specific nature and all the propagation channels of the market turmoil, as well as its intensity and duration. at the current juncture, the outlook for financial stability in the euro area continues to be characterised by considerable uncertainty. the magnitude of the total valuation and income losses facing the global financial system and their distribution across individual financial institutions is uncertain, although several estimates have been made. it is also unclear what the impact will be on the intermediation of credit to the household and corporate sectors. moreover, further tensions in structured credit markets cannot be excluded in view of the ongoing weakness in the us housing market, and there is a risk of adverse developments in the credit cycle. all in all, the risks to euro area financial system stability have materially increased over the past eight months. looking ahead, the ongoing adjustment of global financial markets is likely to last for some time, its interaction with the real economy could prove more wideranging and the shock - absorption capacity of the euro area financial system could be further tested. however,