: new regulatory paradigms, ereport, centre for economic policy research. this literature can be traced back to d. diamond ( 1984 ), “ financial intermediation and delegated monitoring ”, review of economic studies, vol. 51, pp. 393 – 414. see also the discussion in a. kashyap, r. rajan and j. stein ( 2008 ), “ rethinking capital regulation ”, in federal reserve bank of kansas city, 2008 economic symposium, " maintaining stability in a changing financial system ", pp. 431 – 471. european bank bail - in will cost + 87 basis points ”, financial times, october 25, 2010. bis central bankers ’ speeches regards to the bail - in rules. first, about the timing of the implementation of bail - in. the european parliament, for example, wants to have bail - in from 2016. second, about the degree of discretion national resolution authorities will have in applying the bail - in rules, which in my view should be as constrained as possible. this would seem to suggest that, although likely to be priced in to a considerable extent, the ultimate effect of bail - in on funding costs, and its success as a market discipline device, will depend on the final design of bail - in and how markets see it being used in practice. this calls for an early implementation of bail - in as a way to reduce uncertainty for banks themselves and market participants, and allow for a once - for - all repricing of risk. 10 the impact on lending turning now to the effect of bail - in on bank lending, my baseline assumption is that the higher cost of bail - inable liabilities will have a limited impact on bank lending. let me explain. clearly, if overall funding costs were to rise, this could in theory have an effect on banks ’ lending activity : banks may respond by providing less credit and charging higher loan interest rates. that said, i am not certain how realistic this scenario would be in practice. building on the vast literature on the bank lending channel, one can argue that even if overall funding costs increase, there are several factors that can mitigate the transmission of funding shocks to lending. for instance, capital and liquidity buffers11 allow banks to shield borrowers from funding shocks and these are in the process of being strengthened by the basel iii requirements. moreover, the type of relationship between banks and borrowers may affect the way banks translate shocks

jean - claude trichet : financial stability risks intervention by jean - claude trichet, president of the european central bank, at the international monetary conference central bankers panel, frankfurt am main, 5 june 2007. * * * in my intervention i would like to focus on financial stability risks, based on the ecb governing council ’ s most recent assessment. we have been pleased to observe that the external macrofinancial environment for the euro area financial system is robust and it is also projected to continue to develop rather favourably. credit quality in the euro area remains high, and it should be further underpinned by the favourable economic outlook. although pockets of vulnerability in the euro area household and corporate sectors have increased, on average financial positions remain sound. finally, financial institutions, including banks and insurance companies, have shown improving financial results and market participants expect profitability to remain strong also in the foreseeable future. in late february and early march of the current year, the financial system has absorbed smoothly the third significant burst of market volatility in the past two years. this high degree of resilience of the financial system can be attributed also to the continuous improvement in the risk management practices of financial firms. all in all, recent developments and forward - looking indicators together allow us to conclude that the main scenario for the euro area financial stability remains favourable going forward. the fact that the global and euro area financial systems have so far proven resilient to a series of adverse disturbances, while comforting, does not provide any ground for complacency. the episodes of market volatility throughout the past two years were triggered by relatively small and transitory disturbances in an environment of strong macroeconomic fundamentals and abundant financial market liquidity. therefore, it is unlikely that these episodes would provide sufficient guidance on how the financial system would perform in the event of larger shocks that could trigger a more material reappraisal of risks, or a change in risk appetite, at a less favourable stage of the credit cycle. for instance, vulnerabilities could be quickly unearthed if market liquidity – hard to measure but currently seen by many market observers as more abundant than ever – were abruptly and sharply to decline, for example as a result of an unexpected deterioration in investors ’ risk appetite. i would like to highlight briefly three issues that we currently see as important in assessing future risks to financial system stability : hedge funds, private equity sponsored buy - out activity and the markets for credit risk transfer. starting