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Speaking at the Spanish Capital Markets Forum José Manuel González-Páramo, Member of the Executive Board of the ECB, draw some preliminary lessond from the recent financial turmoil.
“Recent events have revealed some weaknesses in the organisation and functioning of the financial system, in particular regarding the market for complex structured products and the liquidity in this market under stressed conditions”, he said and pointed out three key weaknesses:
First, the ability of investors to assess the extent of concentrations among various types of collateral - including sub-prime - within the structured finance securities has clearly been shown to be less than adequate.
Second, market participants were not sufficiently alert to the possibility that liquidity could dry up in structured finance markets, even though secondary market liquidity in the various structured finance markets has been traditionally thin.
Third, the Asset Backed Commercial Paper (ABCP) structures had intrinsic liquidity risk because they invested the proceeds of short term liabilities into longer maturity structured finance assets.
Pointing to the credit market, González-Páramo identified certain supervisory and regulatory issues as warranting further attention or action.
First, transparency for markets, investors and regulators. Recent experience has shown how perceived opaqueness or uncertainty regarding the underlying exposures, in particular of financial institutions, has translated into a loss of confidence with a resulting disruption in the interbank market.
In this context I would like to note that improvements are expected from the implementation of the Basel II framework, namely of the Pillar III requirements, in particular regarding disclosure of risk positions for banks.
Second, valuation of illiquid complex structured products. Given present market conditions and the uncertainty concerning the underlying quality of the assets, there are currently no quotes or market prices for many structured finance products. This lack of comparability and consistency in the valuation of similar assets should be addressed in order to restore confidence in this market.
Third, liquidity risk management, in particular liquidity risk stress-testing and contingency funding plans. The complexity of structured finance products requires banks to have in place commensurately sophisticated risk management systems. Recent events have shown that significant efforts remain to be done in this respect.