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28 June 2012

ECB/Constâncio: Understanding the driving forces behind systemic financial crises


Mr Constâncio said that while considerable progress had been made with respect to understanding the causes, consequences and propagation of systemic financial crises, this knowledge was far from sufficient.

The developments on the global financial markets that we have been witnessing in the past years are unprecedented in nature, and have raised a number of challenges for policy-makers and central banks alike. In times like these it is more important than ever that we use the advice of the brightest and most talented scholars in order to find answers to complex questions and develop effective tools with real-world applicability in order to combat the potentially adverse effects of financial instability without jeopardising our primary mandate of medium-term price stability. Academic research plays an important role for central banks in general because it provides the foundations for the conduct of monetary policy and its impact on the real economy. The Eurosystem is no exception to this and naturally finds itself in constant exchange with the global research community in the form of research seminars and conferences as well as regular academic visitors.

A salient feature of financial institutions that has featured prominently in the current financial crisis is leverage. In fact, most market participants do not finance their entire trading positions with equity but rather fund part of their investments by pledging the securities as collateral in repurchase agreements and asset-backed commercial paper. This implies that asset prices are also affected by funding liquidity, a concept that refers to the ease with which a security can be used to raise outside capital. In the years preceding the 2007–2008 financial crisis, leverage in the financial sector built up steadily fuelled by high demand for dollar-denominated short-term debt in conjunction with low interest rates. When the first rumours of problems in the market for sub-prime mortgages began to spread, uncertainty of exposures to potential losses directly translated into funding liquidity problems.

Further advances are particularly needed in the fields of macro-prudential policy and regulation, and the Eurosystem aims to continue contributing to a filling of this knowledge gap, in particular via its Macro-prudential Research Network and its involvement with the European Systemic Risk Board.

Full speech



© BIS - Bank for International Settlements


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