In my view, this internationally harmonized standard needs to have the following basic features to be effective: •  The standard should reflect a very adverse scenario, including a massive loss of confidence from depositors, a disruption of secured funding and a loss of liquidity on major segments of the securities markets. The new standard will only be able to promote stability if the underlying scenario is severe enough. A moderate scenario is not sufficient to bolster confidence in situations of turmoil. •  The standard should require banks to hold a buffer consisting of assets whose liquidity and value is robust to massive disruptions in the financial markets. The presumption should be that government securities form the bulk of the buffer. Overall, the new liquidity standard should substantially strengthen banks’ liquidity base. Banks must be in a much better situation to weather liquidity shocks without having to resort to public support. As a consequence of these higher capital and liquidity buffers, the relevant banks may seem more boring. Their rate of return on equity will be lower. At the same time, their earnings are bound to be less volatile and they will likely be more beneficial for the economy as a whole. With such changes must come a change in banks’ compensation policies and practices. Compensation cannot be a one-way street and must become risk aligned and long-term oriented. Facilitating the orderly resolution of banking problems Prevention is key but it will not be foolproof.
Strong and bold entrepreneurial and political leadership is now required to see the necessary changes for the financial system through, as demonstrated today by the G20 leaders in Pittsburgh. Clearly, there are many areas in financial regulation that can and in many cases should be improved. Given what is at stake, there is clearly a need to prioritize. I have briefly laid out to you this evening where I see those priorities. Thank you for your hospitality and patience. BIS Review 115/2009  5