Supervisory practices must be revamped so that supervision is also horizontal – looking broadly across banks, nonbanks, markets and geographies. This also means that regulatory standards need to be harmonized  BIS Review 14/2010  2  across different regions. Without harmonization, there will inevitably be a “race to the bottom” and regulatory arbitrage will be encouraged, rather than inhibited. Many steps are needed to make financial institutions and infrastructure more robust. For example, we need to strengthen bank capital requirements, improve liquidity buffers and make financial market infrastructures more resilient to shocks when individual firms get into trouble. In terms of capital requirements, many changes are needed, including global capital standards that put more emphasis on common equity, establish an overall leverage limit and better capture all of the sources of risk in the capital assessment process. Improved risk capture, for example, includes the trading accounts of banks. Some institutions had clearly not set aside adequate levels of capital given the risks that were embedded in their trading positions. It would also be very desirable to develop a mechanism to bolster the amount of common equity available to absorb losses in adverse economic environments. This might be done most efficiently by allowing the issuance of debt instruments that would automatically convert to common equity in stress environments, under certain pre-specified conditions. Such “contingent capital” instruments might have proven very helpful had they been in place before and during this crisis.
Second, we need to reduce the likelihood that systemically important institutions will come close to failure in the first place. This can be done by mandating higher capital requirements, improving the risk capture of those requirements and by requiring greater liquidity buffers for such firms. Although the raging crisis appears to be over, our work is not close to being complete. Making sure this work keeps moving forward and is coordinated internationally is hugely important. Differences in views across countries and regions should not divert the international community from the more important prize – taking the actions collectively that will ensure a robust and resilient financial system. BIS Review 14/2010  4