macroauthorities. prudential authorities would step in and impose ( or relax ) constraints whenever they come to the conclusion that dangerous imbalances are building up ( or unwinding ). we probably cannot dispense of this second approach. the difficulty to date cycles makes it dangerous to rely purely on automatic mechanisms, which cannot be precisely calibrated. financial cycles, in particular, are driven by changes in risk appetite which are impossible to predict. actually, one essential objective of macroprudential supervision may be to " regulate " ( not in the legal sense, but economically ) the aggregate level of risk appetite inside the financial system. this unavoidably involves some degree of discretionary judgement and intervention. combining the two components of macrosupervision ( systemic and macroeconomic ) with the two approaches ( automatic and discretionary ) produces an interesting classification, which is presented in the table below : purpose systemic risk adjustment to macroconditions mechanisms • buffers ( capital and / or liquidity ) • loan to value ratios automatic • accounting framework • stress tests discretionary • pillar ii of basel 2 • time varying ratios capital • dynamic provisioning • discretionary adjustments to capital ratios, provisions or margin requirements institutional challenges the discretionary approach to macrosupervision raises important institutional issues. first, who makes the judgment? and should that body be independent or not? there is a good case for putting central banks in charge. if one takes an historical perspective, it is striking that the mandates and missions of central banks have taken major turns following financial crises. central banks have an informational advantage ( or at least no disadvantage ) in judging the cyclical position. they have an incentive to act, because macroprudential supervision alleviates the burden on monetary policy, and because they need monetary transmission mechanisms to work. so they clearly should have a pivotal role in the process. but they are not alone in caring about financial stability. and experience has shown that price stability – their primary mandate – does not always coincide with financial stability and the avoidance of bubbles. furthermore, in an integrated financial system, judgments have to be made on a worldwide basis. another alternative is the imf. but the imf is mostly controlled by governments and decisions are made according to voting shares. implementing macrosupervision will involve delicate decisions ( like strengthening lending standards in good times ) to which governments may not spontaneously agree. a fully independent body would certainly be necessary. second, how is that judgment

or counterparty risk problems for banks. such situations are also a matter of concern from a systemic liquidity viewpoint, and may take two extreme forms : market liquidity could temporarily dry up or individual funding liquidity problems may affect a significant market player. 9 such liquidity problems are typically lowprobability events, but the potential loss to the financial system if they were to materialise is great. in today ’ s financial markets, the fear is that a large proportion of market participants may have become excessively complacent ; a situation which may well have been exacerbated by high levels of liquidity, the stability of which is difficult to predict. what then can be done to enjoy the advantages of credit derivatives, while simultaneously minimising the systemic risks they could generate? first, we need to understand what the main problem is. here, it should be acknowledged that the opacity of the credit derivatives market, and especially of structured synthetic instruments, is a potential source of concern. the complex interaction between cash instruments and credit derivatives has made it increasingly difficult to monitor where different, possibly sizeable, positions are taken and where risks are concentrated. it is similarly difficult to monitor whether and when simultaneous attempts by market participants to unwind their positions could have an impact on market prices and systemic liquidity. 10 it is therefore becoming increasingly important for risk managers, in both the private and the public sectors to understand which risks are being accumulated by what financial entities. second, since there is no simple solution to the problem of opacity, what is the right direction to take? the challenge is to work towards an adequate transparency framework. more and improved data on net credit risk exposures and on the concentration of positions – which tend to build up easily in highly leveraged and opaque markets – could help to mitigate sizeable shortcomings in both see, for example, imf gfsr ( 2005 ), geithner fed of ny ( 2006 ). see lagana et al. ecb ( 2006 ) and ecb financial stability review, box 9, december 2006. see institute of international finance ( 2007 ) and joint forum ( 2006 ) for further details and definitions. ecb financial stability review, june 2006. counterparty and systemic liquidity risk management. in fact, such data could help market participants and competent authorities to value, price and manage more effectively the increasing risks posed when investors behave in a homogenous way. however, it is important