Whether banks continue to draw down on their capital buffers to maintain lending – or whether they react defensively and deleverage to conserve capital, particularly as they approach Maximum Distributable Amount thresholds for restrictions on AT1 coupons, will be a key area for regulators to watch in the coming months. My initial assessment, however, on what we have seen is that the UK banking system has demonstrated so far that it is likely to be resilient a pretty long way into the tail of adverse shocks. The little thought experiment above illustrates that while building resilience in the financial system in good times might seem expensive, it is the better economic bet over the long run. The other major post crisis reform that we have seen operating under severe stress conditions in recent months is the changes made to derivative markets and particularly the requirement that derivatives trades be prudently ‘margined’ or collateralised against counterparty failure and – where sufficiently standardised – centrally cleared.7  10 years ago, as financial asset prices fell, a complex and under-collateralised web of ‘over the counter’ (OTC) derivative trades between financial market participants was revealed. The resulting exposures and demands for collateral greatly amplified the stress and uncertainty in the financial system.
So, future work should concentrate on how to make the rating process clearer and more explicit and to preserve and strengthen its integrity. A second, alternative view, on the collapse and confidence and liquidity would point at the inadequation of capital to risk in the new securitized model. Ultimately, the ability of an investor to carry risk is determined by her capital base. Capital must be sufficient to absorb the potential losses if risk materializes. If not, confidence may vanish and liquidity may disappear. To quote Stephen Cecchetti 1 , "in the context of financial intermediaries, capital plays the role of collateral". So, for the securitized model to work, there cannot be too big a disconnect between the allocation of risk and capital in the system. This is true both at the aggregate level and for each individual issuer of securities. At the aggregate level, insufficient capital leads to excess leverage and, as a consequence, to excess fragility. For each individual issuer of securities, carrying risks with little (or no) capital increases the probability of a liquidity crisis. It may be that, as time goes by and we look more closely at what happened, this second view will gain in importance. I would note that cracks occurred in those places – the conduits and especially the SIVs – where there was no capital available to absorb shocks.