In one sense, this should not matter if the regulatory capital calculation provides a robust floor below which the “economic” capital should not fall. But it was unclear how we could know this was so, and the lack of line of sight into how the firm managed risk was disturbing. The second weakness is generic to simple systems which conflate different levels of inherent risk, namely that they tend to create incentives for banks to increase the average level of riskiness of their assets. And, one thing we now know, incentives are hugely important in the capital regime. As I noted earlier, Basel II was not in place properly when the crisis broke, but the Market Risk Amendment was, and this introduced the use of banks’ own so-called “internal” models. As an aside, my experience suggests that the contribution of Basel II to the crisis was far more that it diverted the attention and effort of regulators and the industry away from broader risk management and into the implementation of a new and more detailed approach to regulation. This was especially so for large banks seeking approval to use their internal models. Moreover, this process was not well done. The Market Risk Amendment and Basel II dramatically increased the complexity of the capital framework, and whilst it intended to increase the scope of risk capture in the regulatory capital measure it ended up creating new opportunities for “optimising” regulatory capital.
Mervyn King: No country is an island Speech by Mervyn King, Deputy Governor of the Bank of England, at the Institute of Petroleum Annual Dinner, London, 21 February 2001. *  *  *  No country is an island - in terms of economics, if not geography. Trade and capital flows link all the economies of the world. Since 1970 the volume of world trade has increased more than five-fold. Globalisation is not a slogan; it is a fact. The economic winds can rapidly alter direction bringing significant changes in the economic weather. What happens in the world economy is of great importance to your industry. But no business in a country, such as the United Kingdom, which exports and imports almost a third of its national output each year, can ignore global economic developments. Recent events have reminded us of just how volatile that economic weather can be. Only a few short months ago, the United States was experiencing rapid economic growth at a rate which surprised us all. The new frontier had become the new economy, and some had forgotten that economic downturns are a regular feature of a market economy. Share prices had reached levels four times that of a decade earlier, and the price earnings ratio of America's top 500 companies was over forty, an unprecedented level. Now, after a swift and sharp fall of business and consumer confidence, the business cycle appears to be alive and well, and living in the United States.