noted that clo equity does not represent a form of demandable short - term financing and hence does not have the potential to contribute to fire - sale dynamics in the same way as, say, repo financing. bis central bankers ’ speeches another place where the desire to generate yield can show up is in commercial banks ’ securities holdings. in recent work, sam hanson and i documented that the duration of banks ’ non - trading - account securities holdings tends to increase significantly when the short rate declines. 20 we hypothesized that this pattern was due to a particular form of agency behavior – namely, that given the conventions of generally accepted accounting principles, a bank can boost its reported income by replacing low - yielding short - duration securities with higher - yielding long - duration securities. something along these lines seems to be happening today : the maturity of securities in banks ’ available - for - sale portfolios is near the upper end of its historical range. this finding is noteworthy on two counts. first, the added interest rate exposure may itself be a meaningful source of risk for the banking sector and should be monitored carefully – especially since existing capital regulation does not explicitly address interest rate risk. and, second, in the spirit of tips of icebergs, the possibility that banks may be reaching for yield in this manner suggests that the same pressure to boost income could be affecting behavior in other, less readily observable parts of their businesses. the final stop on the tour is something called collateral transformation. this activity has been around in some form for quite a while and does not currently appear to be of a scale that would raise serious concerns – though the available data on it are sketchy at this point. nevertheless, it deserves to be highlighted because it is exactly the kind of activity where new regulation could create the potential for rapid growth and where we therefore need to be especially watchful. collateral transformation is best explained with an example. imagine an insurance company that wants to engage in a derivatives transaction. to do so, it is required to post collateral with a clearinghouse, and, because the clearinghouse has high standards, the collateral must be “ pristine ” – that is, it has to be in the form of treasury securities. however, the insurance company doesn ’ t have any unencumbered treasury securities available – all it has in unencumbered form are some junk bonds. here is where the collateral swap comes in. the insurance company might approach a broker - dealer and engage in what is

is high, the interest rate has the merit of setting the universal price of leverage. it reaches parts that other instruments cannot reach. ” bis central bankers ’ speeches the same time engaging in mep - like asset swaps to flatten the yield curve and reduce the appeal of maturity transformation. conclusion i hope you will take this last example in the spirit in which it was intended – not as a currently actionable policy proposal, but as an extended hypothetical meant to give some tangible substance to a broader theme. that broader theme is as follows : one of the most difficult jobs that central banks face is in dealing with episodes of credit market overheating that pose a potential threat to financial stability. as compared with inflation or unemployment, measurement is much harder, so even recognizing the extent of the problem in real time is a major challenge. moreover, the supervisory and regulatory tools that we have, while helpful, are far from perfect. these observations suggest two principles. first, decisions will inevitably have to be made in an environment of significant uncertainty, and standards of evidence should be calibrated accordingly. waiting for decisive proof of market overheating may amount to an implicit policy of inaction on this dimension. and, second, we ought to be open - minded in thinking about how to best use the full array of instruments at our disposal. indeed, in some cases, it may be that the only way to achieve a meaningfully macroprudential approach to financial stability is by allowing for some greater overlap in the goals of monetary policy and regulation. thank you very much. references amromin, gene, and steve sharpe ( 2012 ). “ from the horse ’ s mouth : how do investor expectations of risk and return vary with economic conditions? ( pdf ), ” federal reserve bank of chicago working paper 2012 – 08. bernanke, ben s., and mark gertler ( 1989 ). “ agency costs, net worth, and business fluctuations, ” american economic review, vol. 79 ( march ), pp. 14 – 31. borio, claudio, and mathias drehmann ( 2009 ). “ financial instability and macroeconomics : bridging the gulf, ” paper prepared for the twelfth annual international banking conference, “ the international financial crisis : have the rules of finance changed? ” held at the federal reserve bank of chicago, chicago, september 24 – 25. campbell, john y., and john h. cochrane ( 1999 ). “ by force of habit