looking at the same thing. a weak or misused classification system would destroy any such process. as critics correctly have noted, such an approach has the potential to create procyclical swings in the minimum required capital of banks as the risk classifications of credits migrate up and down in conjunction with the state of the economy. i think this is an example of what i referred to at the outset : regulations in banking will have their own cyclical responses as events move banks toward and away from minimums. but that also would be the case for self - imposed management guidelines in an unregulated world. let me emphasize that the basic cause of procyclical bank lending is less the result of rules - regulatory or self imposed - - and more our difficulty in predicting the future. no lender starts out to make loans that default. risk management does not enable us to perceive unfolding events with any greater clarity. but it creates an analytical structure and enforces reference to past events and, in so doing, eliminates consideration of or suggests higher pricing for loans with a low probability of repayment. enhanced risk management, by increasing our ability to focus better on probabilities, will tend to flatten cyclical lending patterns. indeed, though we are not going to eliminate cyclically correlated changes in attitudes of human beings, i am impressed by the effect that facts, historical relationships, and quantification can have on reducing such swings. first, relative to what we have today, basel ii is endeavoring to reduce cyclical reserving and write - offs that traditionally have come with the late recognition of excess risk taken earlier. second, the supervisory leg of basel ii is being structured to supplement market pressures in urging banks to build capital considerably over minimum levels in expansions as a buffer that can be drawn down in adversity and still maintain adequate capital. finally, negotiators in basel continue to fine - tune the proposed accord in ways that promise to damp cyclical swings in capital requirements relative to what was implied by last year's proposal. conclusion to sum up, i think it is worth saying again that, as high - quality borrowers deserted banks for the commercial paper and direct debt markets, banks have tended to move in ways that, at a minimum, reinforce the business cycle. but technology, innovations, and increasingly efficient capital markets have reduced that contribution to the overall macroeconomic cycle. new developments in risk management hold the promise of further reductions, and they may already have

. 251 ( 1913 ). bis central bankers ’ speeches for as long as they have existed, central banks have calmed financial crises by lending to financial institutions against good collateral. because central banks step in when other sources of funds retreat, central banks acting in this capacity are known as lenders of last resort. but that phrase doesn ’ t mean that central banks make bad loans ; nearly all of their loans are to sound borrowers with sound collateral. banks rely on short - term funding such as overnight interbank loans or customer deposits to make the longer - term loans their customers need. if funding becomes scarce, banks become less willing to extend credit. to maintain the flow of credit to businesses and consumers, the federal reserve provides short - term credit to sound depository institutions as needed. to ensure that banks use the facility only as a backup source of funds, federal reserve loans are made at an abovemarket rate. in the panic of 2008, liquidity needs were not confined to the banking system. the shadow banking system, made up of investment banks, money market funds, finance companies, and investors in a wide range of debt securities, provided a large part of the credit that fueled our economy. when panic set in, it froze lending in banks and non - banks alike and produced funding pressures across a wide range of markets and institutions. the actions taken by the federal reserve to fight the crisis were quite traditional in the sense that, for years, central banks have been providing liquidity by lending to financial intermediaries. but they were unconventional in that the concepts had to be adapted to fit markets and lenders that had never been supported by the federal reserve before. now, i didn ’ t live through the banking crises of the distant past or those that might have occurred in other countries. but i can tell you what it was like at the center of the most recent crisis. funding was drying up for one institution after another and for one market after another. our efforts to provide liquidity were criticized by some as bailouts for the banks. i can understand how it could seem that way, but i also know that every action the fed took was directed at improving the economy rather than the well - being of the banks. we had to make many difficult decisions in the darkest days of the crisis. for me, the decisions were made a bit less difficult by several factors. first and foremost was the calm, decisive leadership by chairman bernanke, whose lifelong study of economics and economic history provided unique