The risk to the financial system is not equivalent to the average risk to individual firms. This was strikingly illustrated in the crisis, as it was individual institutions’ attempts at self-preservation that transmitted and amplified stresses throughout the global system. Addressing system-wide risks requires new tools, and here, too, there has been considerable progress.
The countercyclical capital buffer included in Basel III is a giant step forward. The Bank of Canada played an important role in the development of the buffer, which provides for additional capital to be built up during periods of excessive credit growth in anticipation of a future downturn. This broad macroprudential instrument complements other tools designed to contain financial imbalances in specific markets.