New markets, new customers, new products, new technology: the risks of something going wrong are high if the industry's risk assessment procedures and control mechanisms do not keep pace. The impetus behind all these changes is intensified competition. This is good news for financial efficiency, and given that this is also one of the Bank of England's core interests, we welcome it. But there are undoubtedly some implications for financial stability, at least in transition. An increase in competitiveness may for a period increase the financial system's vulnerability to shocks; academic research suggests that the process of financial liberalisation can increase significantly the probability of a banking crisis. So how do we make this trade-off acceptable, given that we certainly do not want to exchange the overt costs of financial crisis for the hidden costs of financial protectionism? 2  BIS Review 43/2001  Policy response to the changing environment Well, a large part of the answer must be to strive for improvements in the financial and regulatory infrastructure – to 'risk proof' the system as it were. There are a number of very significant initiatives that are worth mentioning in this context. The proposed new Accord from the Basel Committee is deservedly the focus of a number of the papers to be presented at this conference. A large slice of our time here is also going to be devoted to evidence on the effectiveness of market discipline on banks.
The first one, which we may call the pan-European approach, has tended to produce a lot of numbers on aggregates and averages in the financial stability analysis. No country wants to stick out in the assessment; they hide behind these broad numbers. But you cannot identify weaknesses and vulnerabilities through averages. “On average”, banks’ credit portfolios and capital ratios may be robust but an FSAP should look for the outliers – the ones which will break first. Whichever approach you select, you would need to include a detailed analysis of those major financial groups which cross the borders between the European countries and sometimes also operate outside the region. These groups are in many cases so large that they could influence countries both positively and negatively depending on developments. Let me give you a recent example from my own country: Icelandic investors have bought large stakes in Swedish financial firms. The investments are rather small from the Swedish point-of-view but significant for their parents in Iceland. Recently, there has been volatility in the Icelandic financial and currency markets. Luckily, the investments in Sweden are doing very well and have rather contributed to strengthening the Icelandic financial system. But in another situation the reverse could have been true – had the Icelanders made these investments during the Swedish banking crisis in the 1990s the Swedish holdings would have contributed to weakening the Icelandic economy.