Together these approaches provide firms and us with the tools to do two things: to add up overall capital requirements; and as diagnostic tools to allow the probing and analysis of strengths and weaknesses of firms’ positions. I cannot emphasise enough that good judgemental supervision which is forward-looking employs diagnostic tools. None of these tools will provide the “right” answer, they are not tablets of stone. They enable assessment and challenge, by managements, boards and supervisors. The idea that we could rely on one of these tools alone, which you can read in some books, is, let me be blunt, naïve. Good supervision looks at things from different angles in order to build up pictures. In the same vein, I do not agree with those who say that we should disallow firms’ internal models. That amounts to saying we are not interested in how firms’ manage their own risks and that somehow we have better models to use. But, we don’t rely exclusively on firms’ models, and we challenge them hard; and we throw them out when we don’t like them, and we have done that. Good prudential supervisors are bold enough to do that. The lesson is look at models, but do it properly, and to do that is not a simple job.
We take all of our responsibilities very seriously, as of course we should. Across the board, there have been developments over the last year that give me a sense of cautious satisfaction – by the way, that is at the happier end of the spectrum of emotions for a central banker Seriously, I am afraid that we must not get carried away here. We are in many ways in the second phase of the financial crisis. The first phase was a prudential one, while the second phase has revealed past misconduct. Fixing the financial system requires more than just fixing capital and liquidity standards. Standards of governance, conduct and the right incentives structures are all extremely important. After commenting on two material development this year I want to use the rest of my time to set out four areas where we are either taking action, or watching very carefully to determine whether action may be required. Let me start by describing two developments which point to some cautious satisfaction. First, the capital position of UK banks has strengthened. Market conditions have supported actions to raise capital and reduce non-core assets, and banks have taken advantage of those conditions. The targets that were set as a consequence of the FPC and PRA exercise of nearly two years ago have been met ahead of schedule. The banking system is now more able to support lending and the growth of the economy.