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Last week, in his quarterly "Monetary Dialogue" with the EU’s Committee and Monetary Affairs, European Central Bank (ECB) President Jean-Claude Trichet said that greater transparency regarding sophisticated financial instruments and better risk management by banks and financial institutions were among the ways to restore confidence in the money markets. This message was also delivered earlier in the day by Internal Market Commissioner Charlie McCreevy.
Trichet explained the reasons for the necessary injection of short term liquidity to the market undertaken by the ECB and sparked by the crisis in the US sub-prime mortgage market. When asked whether banks which had behaved recklessly were being let off the hook, Trichet stressed that "Central banks and certainly the ECB will not bail anybody out. We lent at interest, on a 24 hour basis, with collateral. We are not pouring money into bad behaviour. We are permitting the market to function properly so that those who behaved well do not end up being punished by the turbulence. Those who behave improperly will have to pay the price."
Turning to lessons which might be learned from what he characterised as "a market correction with a significant reappraisal of risk", Mr Trichet said the ECB had repeatedly warned that markets were showing an "under-appreciation of risks in general." He said "the degree of complexity of some products designed for the purposes of repackaging and selling debt instruments has become overwhelming." He argued that both those selling such products and those buying them had a responsibility to understand and manage the risks involved, and further improvements were needed in regulators' surveillance activity to ensure they did. The Basel II arrangements would help, but not solve all the problems. "It is true", he added, "that the very small number of large global ratings agencies is a real issue for the present functioning of global finance."
Last Tuesday morning, Commissioner Charlie McCreevy similarly stressed the need for transparency and better risk management, but highlighted the Basel II (banking), MIFID (financial instruments) and Solvency II (insurance) projects were designed to achieve this, but were not yet in operation. He was strongly critical of the ratings agencies: "they were very slow, they had weak methodology, and there is a potential conflict of interest between providing an objective risk assessment and advising institutions on how to structure instruments. We need to know what agencies do and what they don't." A number of MEPs criticised the Commissioner for, as they saw it, being slow to act on ratings agencies, despite a call from Parliament in its previous term of office for a report on this issue.
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