thus under - price the respective financial assets. exaggerated pro - cyclicality of this type has hit the sovereign bond market during the crisis. furthermore, in particular through the use of sovereign bonds as collateral, it has exerted adverse effects on other segments of financial markets, such as the funding markets for financial institutions. to remedy exaggerated pro - cyclicality does not mean that we should dispense with the disciplining role of financial markets. the history of the monetary union teaches us an interesting lesson : when the disciplining role of intra - euro area exchange rates was lost, volatility and tensions have in fact migrated to sovereign debt markets, where they were building up under the surface. even though markets sometimes misprice assets, they nevertheless provide a useful service in terms of signalling, price discovery and incentives. for example, if markets had not pushed up the yields of countries in weak fiscal positions, imbalances would have remained unnoticed and grown much larger, and the cost of fixing them would have been even higher. while attenuating exaggerated pro - cyclicality is important to avoid self - fulfilling expectations leading to bad equilibriums, at the same time we should recognise that markets have issued valuable signals. there are a number of ways to mitigate exaggerated pro - cyclicality of government bond markets. one way is to reduce the reliance of the financial, regulatory and supervisory framework on credit ratings. the european commission has put forward a number of proposals to this end. similarly, it is worth considering ways to delink the risk assessment of credit institutions from the credit rating of the sovereign. in addition, risk management by bis central bankers ’ speeches central clearing counterparties or ccps is of particular importance, as an increasing number of financial transactions is expected to migrate to them. the cpss - iosco principles for financial market infrastructures expect ccps to adopt forward - looking and conservative margin and haircut policies to limit the risk of destabilizing responses to changes in credit ratings. but to address the root causes of the current instability, fundamental policies will have to be adopted. the adverse feedback loop between banks and sovereigns, that i mentioned before, can be broken by establishing a true financial union : in my view this includes the creation of a pan - euro area deposit insurance fund and a pan - euro area bank resolution framework, supported by a single supervisory system with centralised decision - making. if the european stability mechanism – an institution that can provide financial assistance to euro area member states

with the sharp decline in sovereign bond prices – often associated with a rating downgrade of the respective sovereign issuer – government bonds were made subject to significant haircuts and their refinancing power declined. this has eroded the volume of collateral available in the form of government bonds and stressed the re - financing possibilities of banks. fourth, the re - pricing of government debt also had a direct negative impact on the asset side of banks and therefore on their own perceived riskiness. in fact, since 2009, we can see a close relationship between measures of bank and sovereign credit risk. this sovereign - bank nexus constitutes a fundamental impediment to resolving the crisis in the euro area. on the one hand, rising sovereign credit risk affects banks ’ credit risk via their exposure to government debt. this creates deleveraging pressure that may turn into disorderly dynamics characterised by fire sales. on the other hand, ailing banking sectors increase the burdens faced by governments. these two effects are mutually reinforcing and constitute a vicious circle. for the banks, the increase in their own credit risk makes their re - financing harder. in short, unsecured financing is hampered by the perception of increased bank riskiness while secured financing is undermined by the erosion of collateral. this can in turn become a major obstacle to granting loans to the real economy. as banks are the main source of financing in the euro area, this could seriously jeopardise the flow of credit to enterprises and households. what lessons have we learnt? these developments in the euro area sovereign bonds markets offer one clear lesson : financial markets are prone to exaggerations, which amplify further the pro - cyclicality inherent in asset valuations. usually, during “ good times ”, when risk appetite is strong and economic conditions are favourable, asset prices tend to be high and risk spreads tend to be low. however, financial markets tend to be over - complacent from time to time, especially after protracted periods that did not see any extreme events materialising. this tendency has probably led to an excessive tightening of euro - denominated yields in the run - up to the euro. in “ bad times ”, when the degree of risk aversion increases and gdp growth contracts, asset prices tend to decline and risk spreads rise. also in bad times, this standard pattern of procyclicality may be amplified by market exaggerations : investors tend to over - price certain types of risk and