William J McDonough: The role of financial stability An address by Mr William J McDonough, President and Chief Executive Officer of the Federal Reserve Bank of New York and Chairman of the Basel Committee on Banking Supervision, at the XIII International Frankfurt Banking Evening, Frankfurt, Germany, 3 May 2001. *  *  *  Mayor Roth, President Duisenberg, and distinguished guests… It is an honor to address the thirteenth International Frankfurt Banking Evening in a setting so rich in history and tradition. I have been told that this stately building is more than just the busy town hall for a major European city, it is also an ever-present witness to culture and history, having hosted banquets and celebrations for almost six hundred years honoring coronations and the visits of Presidents and Prime Ministers. Indeed, it seems highly appropriate that our dinner this evening, which recognizes the importance of banking and finance to this distinguished city’s heritage, is being held here, so close to one of Europe’s most historic marketplaces. Since medieval times, merchants have traveled great distances to participate in Frankfurt’s many fairs and markets. The wealth that those markets produced no doubt assisted in the development of increasingly sophisticated financial institutions and a stock market as early as the 16th century, plus several of the most storied banking houses in history. Those institutions, in turn, contributed to Frankfurt’s ascent to prominence by financing additional trade and commerce here and abroad.
The philosophy of prevention: assist banks to govern themselves In developing regulations and practices that help to prevent financial crisis, supervisors must not lose sight of the inherent self-interest that banks have to retain the public’s confidence by maintaining safe and sound operations. No responsible firm seeks to fail, and no responsible bank would willingly engage in practices that would cause the market to doubt its long-term viability. Consequently, our role as regulators is not to limit banks’ opportunities for growth and profit. Instead, it is to help banks to improve continuously their abilities to manage their businesses and their risks, thereby ensuring that, across the financial system, banks can maintain their financial health. At the same time, if we are to encourage responsible behavior, we must not create the illusion that we will rescue every institution that does not succeed. In this regard, you will recall Goethe’s view: "What government is the best? That which teaches us to govern ourselves." Similarly, one of the best ways for supervisors to carry out the duty of prevention is by developing regulatory structures that encourage banks and their managers to govern themselves and control their risks. I believe that three important elements in a supervisory structure can help to create such incentives and thereby promote stability. The first consists of the relatively new "risk-focused" approach to bank supervision that is being adopted in financial centers around the world. It embodies a forward-looking perspective focusing most heavily on the risks that each individual bank faces.