I think it has the following four features: •  First, its aims to limit the distress to entire financial systems rather than distress to individual institutions. •  Second, its chief aim is to avoid large and burdensome costs to the economy – such as expensive bank bailouts – rather than aiming to protect more narrowly the depositors of an individual bank. •  Third, it is based largely on the assumption that at least some of the risks faced by the banking system collectively differ from those faced by individual banks. In other words, the risk to the system is not simply the sum of risks to individual banks. •  And, fourth, it aims to examine risks that arise from the interaction of banks as part of a financial system rather than on a bank-by-bank basis. While having sound and sturdy building blocks of the system is essential, it is also essential to understand how they all fit together in a framework and this is where the macro prudential perspective becomes critical. In short, the difference between the two pillars of micro and macro prudential surveillance is between a system-wide health check and ensuring that individual banks are inoculated  BIS Review 106/2006  7  properly from disease. The macro prudential pillar takes account of those risks that may affect all, part, or most banks in the system - and not just individual banks.
Thus risk-based supervision and proper risk assessment by banks are essential measures to bring about financial stability. In this regard Basel II will no doubt help strengthen our collective financial systems by encouraging banks to adopt stronger risk management mechanisms. Pillar 2 of Basel II will add to the stability of the financial system by providing a deeper and richer mechanism to evaluate a broader range of risks - including risks that will impact on the system more broadly - such as credit concentration risk. Encouraging greater transparency by banks under Pillar 3 also contributes to making financial systems more resilient by providing a consistent framework across national boundaries for analysts to do their job in identifying weak or risky banks. Ensuring the soundness of individual banks – what some people now call the "micro prudential" perspective – is, however, only part of ensuring a sound financial system. Bank supervisors these days now talk about "pillars" and in addition to the three pillars of Basel II I believe that there are also two pillars of financial stability. One of these is the micro prudential perspective. The other one is the macro prudential perspective. They are mutually reinforcing and both are essential for ensuring financial stability. An important movement in the last decade has been a much more explicit emphasis being given to the macro prudential aspects of banking supervision by central banks as well as academics and other market observers. What do we mean by macro prudential aspects?