Hence, there is much to be gained in terms of greater resilience and efficiency of the financial system through the design of regulatory and supervisory frameworks aimed at combating the factors that underlie a poor assessment of risks at their root. In this sense, a sound prudential framework should provide financial institutions with the right incentives to properly assess and monitor the risks of their investment and lending policies, incorporating them accordingly into their pricing decisions. Increased awareness of risks, and how these evolve along the business cycle, favours earlier reactions to changing conditions and smoother adjustments in the flow of credit, thus reducing the likelihood of episodes of abrupt liquidity and credit contraction. The New Capital Accord, known as Basel II, is an example of a prudential framework that makes the foregoing principles I have outlined its centrepiece, since it seeks to strengthen the stability of the international banking system by promoting the implementation of more robust and comprehensive risk management practices. It does so mainly by establishing a more precise and sensitive system to link banks’ real risks and the minimum regulatory capital requirements, and by imposing higher levels of transparency in banks’ financial reporting, hence fostering closer scrutiny by market participants. A more risk-sensitive capital framework tends to make banks more watchful of the actual risks of lending policies focused on short-run targets, such as market share or portfolio size, which presumably are important ingredients in periods of credit booms sustaining speculative activities.
This makes sense, particularly in view of the special liquidity requirements I have already mentioned. In addition, we also place funds in small cap companies. In terms of market capitalisation these holdings only account for a small portion of our equity portfolio, but in numbers they make up about three-quarters of all the securities we hold. This, too, shows the breadth of our equity universe. When selecting our equities, we use a benchmark. This is a combination of various commonly used indices, assembled by us. As soon as we have determined the benchmark, equity investment becomes a largely automatic process. Why does the SNB not make targeted investments in individual companies or sectors where an above-average return can be expected? In other words, why do we not engage in stock picking? Warren Buffett is quoted as having said, wide diversification is only required when investors do not understand what they are doing. I can assure you that our investment specialists have an excellent understanding of what they are doing. However, we choose to have recourse to a broad equity universe for the following four reasons. First, we achieve a greater diversification effect within the equity segment by investing as widely as possible, across both regions and sectors. Second, it should not be our objective to enforce strategic or, indeed, political interests by means of our investments in individual companies. This could limit our monetary policy room for manoeuvre and would also make our position vulnerable.