A resilient and innovative banking system will support the efficient allocation of capital and therefore technical progress and growth. Financial markets are fundamentally about risk-taking: credit risk, liquidity risk and market risk are basic components of even the safest and soundest banking systems. As a society, we need risk taking as part of the process of allocating capital to competing ends. And people who take risks – at least with their own money or their own careers – need to be rewarded (appropriately!) for that risk or they won’t take it. So we are not in a world where, as a matter of policy, we want to eliminate financial risk. The key is for financial risks to be properly appraised, priced, managed and provisioned. And we should discourage some of the cross-subsidisation of different types of risk taking if we want risk capital to be appropriately allocated. That includes any perceived public subsidy, which is what the ICB recommendations are about. We also want to avoid profits being made  2  The Forum, City AM, page 20, September 14 2012 (http://www.cityam.com/forum/why-britain-s-banking-rulesaren-t-restricting-our-economic-recovery)  BIS central bankers’ speeches  5  out of dishonest practices such as insufficient provision of information, the deliberate mis-pricing of risk or other market abuses. The new Financial Conduct Authority will have an important role to play in that. The regulatory reform process will inevitably take time. And while the process is developing there are risks arising from the uncertainty that it brings. We need banks to raise more equity capital.
There are large sums of money arising from savings or other cash balances which must be (re-)invested somewhere. Returns from the safest sovereign assets have been driven to very low yields. And even some risky assets – like bank debt – are getting scarcer as a result of policy actions, directly or indirectly. Where are asset managers putting the money? BIS central bankers’ speeches  3  Chart 4 Financial market volatility(a)(b) Interest rates (RHS) CDS premia (RHS) Equities (LHS) Foreign exchange (LHS)  Per cent  100  Basis points  300 250  80  200 60 150 40 100 20  50  0  0 07  08  09  10  11  12  Sources: Bloomberg, Chicago Mercantile Exchange, NYSE Euronext, JPMorgan Chase & Co. and Bank calculations. (a) Three-month option-implied volatilities. (b) Average of FTSE 100, S&P 500 and Euro Stoxx 50 for equities. Average of three-month short sterling, euro-dollar and Euribor for interest rates. Average of five-year on-therun iTraxx Europe main and CDX North America investment-grade for CDS premia. Average of three month € $ $ Yen per $ and € for foreign exchange. There has been a renewed search for investible assets going on. Not the old, indiscriminate, invest-in-anything-with-a-high-return-and-ask-no-questions “search-for-yield”. It has so far been a much more calculated hunt. Not so much for return on capital but return of capital. Credit and liquidity risks are now being much more thoroughly appraised. In particular, investment firms have been avoiding the least liquid products.