, the end - 2012 recession gave way to a remarkable expansion in 2013. furthermore, against the backdrop of significant monetary easing there are indications that deflation finally may come to an end. in a nutshell : the advanced economies have entered 2014 in better shape than they were one year ago. but they are far from being in good shape. the economic improvements were backed by the extraordinary low policy rates and unconventional measures by central banks. insofar monetary policy can be regarded as successful. but it came at a price. monetary policy is in uncharted territory. questions came up whether further monetary easing could have diminishing or even negative returns. against this background, sizeable downward risks and vulnerabilities continue to exist. in addition to those mentioned in the background note, i will briefly focus on the fragilities of the recovery in the context of financial market developments. bis central bankers ’ speeches in 2013 there was only one way for most asset prices to go : upward. the eurostoxx 50 increased by 18 %, the ftse 100 by 14 %, the dow jones by 28 %, and the nikkei skyrocketed even by 57 %. funding conditions for troubled sovereigns and banks eased significantly. market volatility decreased, too. after years of risk aversion, sentiment switched to a “ risk on ” mode. 2013 was a very good year for financial investors. however, i look at these developments with some unease. indeed, catching - up dynamics after excessive pessimism up to the summer of 2012 can explain some of the asset price increases. yet abundant global liquidity in addition to abating risks and improving fundamentals has certainly played a role, too. one might even argue that the influence of ultra - loose monetary policies has begun to be stronger on financial asset prices than on real activity. the contrast between buoyant financial markets, on the one hand, and still limited improvements in economic fundamentals and activity, on the other, is apparent. the low volatility we have observed over the last quarters might even have blurred market participants ’ risk perception. did financial markets enter a new phase of “ irrational exuberance ”? such a verdict is certainly debatable. but at least financial markets have anticipated significant further improvements of economic fundamentals and prospects. this creates vast room for negative confidence shocks. the global financial crisis taught us how detrimental contagion and a negative feedback loop between the financial markets and the real economy can be

be addressed. to improve the comparability of the methods used to calculate the capital requirements, the basel committee is aiming to curtail banks ’ leeway in weighting risk. for example, it is hard to assess the probability of default for low - default portfolios which include exposures to sovereigns, large companies or banks because – as the name suggests – the respective credit events are very rare. to some extent, the calculation of regulatory parameters for such low - default portfolios falls under what is known as the “ turkey illusion ” : imagine you are a turkey. every day you are approached by a man who feeds you. what kind of mental model of what happens when he appears do you think you ’ ll build up? however, thanksgiving is coming … measures under consideration to reduce the leeway for banks using an internal - ratings based approach include the implementation of floors based on the standardised approach, restrictions on using internal estimates of certain parameters for risk calculation purposes, and the exclusion of certain asset types from the model - based approach. efforts are also underway to make the standardised approach more risk - sensitive. however, it should be noted that using different methods to calculate risk - weighted assets is not a problem per se. to some extent, deviations are acceptable and reasonable ; otherwise we would ultimately be calling into question the very rationale of the internal models - based approach. bis central bankers ’ speeches 3. beyond basel iii when basel iii is fully implemented, regulatory capital requirements will be significantly higher and tougher than under basel ii, and the financial system will be more stable than before. a typical credit institution will have to achieve a capital ratio of 8 % plus various buffers. but will that be enough? to give a profound answer to this question, we would first need to have an idea of what would be an optimal, or at least an adequate, capital ratio. academic research on this subject is not very broad. however, a recent study by several central bank economists found that a capital ratio of around 11 % would be a reasonable figure. 2 that number exceeds the basel iii minimum requirement but falls well short of “ more radical proposals ”. of course, there is a trade - off between the benefits and costs of higher capital requirements which lies at the heart of the optimisation problem in the study i just mentioned. on the one hand, higher capital requirements reduce bank leveraging, the risk of bank failures and the implicit subsidies given to banks on account of deposit insurance