In the Basel I era, I remember that conversations with banks often began with them saying: “we are happy to discuss risk-based capital requirements as you the supervisors measure them, but that is not how we manage risk”. This statement would not have been bad had the Basel I approach acted as a restraint on how firms took risk, whether or not it was how they measured risk. Unfortunately, that was at best only partially true. Basel II is much criticised, and there is much to criticise, but one thing we should not forget is that it had barely been implemented when the financial crisis began, indeed Basel II was not implemented in the US at all. The excessive leverage and risk-taking had grown up in the Basel I world. Interestingly, in the US, unlike in Europe, banks were effectively constrained from balance sheet expansion by a regulatory leverage ratio. But their response to this constraint appears  BIS central bankers’ speeches  1  to have been to seek a higher return on equity through holding riskier assets drawn from, for instance, sub-prime and leveraged loans. When we look at the causes and types of bank failures in the crisis, the point is often made in this country that the problems appear to have been located in mortgage and commercial property lending as much as investment banking. That is true.
That has been responsible for  BIS central bankers’ speeches  1  an unusually weak recovery in consumer spending which, after falling initially by some 7%, is still more than 4% below its peak. The result is a large number of vacant retail premises – visible here in Belfast, as elsewhere. The second factor is the extent to which the balance sheets of the major UK banks had grown before the crisis hit, and had been financed primarily by borrowing. So the subsequent reduction in bank lending – the deleveraging – was greater here than in many other countries. That deleveraging has as its counterpart a reduction in the amount of (broad) money in the economy and a reduced willingness on the part of banks to expand lending to finance the recovery. And the third is the crisis in our main trading partner – the euro area – where the near term outlook is weak, and the longer term prospects for tackling the evident fault lines in the monetary union uncertain. The former means that our current account deficit has remained stubbornly high, and the latter is holding back corporate investment With a disappointingly slow recovery, and unemployment one million higher than before the crisis, the main aim of economic policy has been to generate both a recovery and a rebalancing of the economy, and bring unemployment down without putting at risk hard-won medium-term price stability. The Bank of England has played its part by administering a powerful combination of medicines.