. figure 1 illustrates what a creditor ’ s assessment of the net worth of a financial firm might look like in normal times. creditors have uncertainty about what that value is, thus, the valuation is represented by a probability distribution. the higher the degree of uncertainty, the greater is the degree of dispersion in the probability distribution. as long as the probability distribution is sufficiently far to the right – in other words – well within positive territory so that there is virtually no risk that the firm is insolvent, lenders will generally be willing to lend. so what happens in a financial crisis? first, the probability distribution shifts to the left as the financial environment deteriorates and the financial firm takes losses that deplete its capital. second, and even more importantly, the dispersion of the probability distribution widens – lenders become more uncertain about the value of the firm. these two phenomena are shown together in figure 2. a lack of transparency in the underlying assets will exacerbate this increase in dispersion. as the degree of dispersion widens, a portion of the probability distribution falls into negative territory. this means that there is a real risk of loss for unsecured creditors if the firm were forced to liquidate its assets. finally, in a crisis, unsecured lenders become more uncertain about others ’ assessment of the probability distribution. for example, if creditor a believes the probability distribution looks like figure 1, but at the same time is concerned that creditor b views the probability distribution as looking like figure 2, creditor a may pull back. if there is a risk creditor b and others will not lend, the firm may not receive sufficient funding. in other words, even if creditor a believes the firm is solvent, it may not lend because it does not want to risk a delay in repayment. so what can creditors do to mitigate these risks? first, they can respond by charging a higher interest rate in compensation for the increase in the risk of default. however, there are a number of difficulties that limit how well this works in practice. most significantly, by undermining the firm ’ s profitability, the higher interest rates may increase the risk of insolvency. if higher rates push insolvency risk up sharply, then higher rates may not be sufficient to make lending – even at higher rates – an attractive proposition. in addition, some investors such as money market mutual funds may have

to allow canadians to have confidence in the country's financial system. on the financial stability side, we carry out a regular assessment of the risks in our financial system review. in december, our overall conclusion was that canada's financial, non - financial, and household sectors are in good shape. this assessment reflects favourable fundamentals – especially solid domestic and global growth, and the prudent financial behaviour of business. of course, there are always risks. in december, we mentioned the possible spillover effects of an abrupt slowdown in the u. s. economy, which may affect the financial health of customers of canadian banks, and a possible disorderly resolution of the large, global current account imbalances, but the canadian financial system appears to be in a good position to withstand such shocks, should they occur. on the efficiency side, our view, as expressed in the governor's december speech to the economic club of toronto, is that canada could be doing better in a number of areas, especially in the regulation of financial institutions, securities markets, and pension plans, and in the enforcement of laws governing securities markets. in carrying out our financial system work, can we do better? a sound and efficient financial system requires constant vigilance. we plan to maintain this vigilance, and to continue our research into financial system issues to help us promote stability and improved efficiency. specific goals for the next two or three years are : to develop a more formal framework to assess financial system stability ; to improve the collection and use of financial data ; and to enhance the ability of the financial system to continue operations in the face of serious disruptions. we also plan to have our financial system research and policy evaluated by an external party. the third and final responsibility i'd like to look at is the design and distribution of bank notes. bank notes bank notes are the most tangible part of a central bank's work. everyone uses paper money. i should point out something that might surprise some of you here in the " technology triangle " – despite the many alternatives to cash, the demand for cash continues to grow, roughly in line with nominal gdp growth. the main objective of our bank note work is to provide canadians with paper money that can be trusted – money we can use with ( here's that word again ) confidence. of course, bank notes should also be beautiful, durable, and easy to handle, but if they can't be used with confidence, either because of