It would probably be hard to achieve that without influencing domestic credit-supply conditions, in booth the boom and contraction phases. (b)  Possible instruments: capital requirements, risk weights and haircuts  There are two dimensions to pursuing this objective. One is making the system more resilient in the face of severe shocks by acting on its inter-connectedness. The other is seeking to adjust the capital and liquidity resources of the system during the up and downswings of the credit cycle; that is to say, over time. Internally, we refer to these as the “cross-sectional” and “time-series” dimensions. I am going to focus mainly on the latter this evening. Work is already underway in Basel to reduce the pro-cyclical properties of the Second Capital Accord and to encourage dynamic provisioning against expected credit losses. On the face of it, that seems unlikely to be enough to deliver a “dynamic resilience” objective in the terms I have described, as it would not directly address stress scenarios. That is a point of departure for the wider debate on extra instruments. Much of the existing public commentary starts from an assumption that any such instrument should be variation in required minimum capital ratios over the course of the credit cycle. We are currently doubtful about that. But we agree that macroprudential instruments directed broadly at taming the credit cycle will be functions of – dare I say, derivatives of – micro prudential requirements on capital and liquidity.
10 (d)  Leakage  From the outset of this debate, I have stressed the hazards in trying to steer credit growth in a world in which capital can flow freely across borders. Think of a case where the domestic authorities increased the risk weight on mortgage lending. The measure would apply only to banks headquartered here or operating out of a subsidiary. It would not apply to branches of foreign-headquartered banks, still less to pure cross border activity. But it is easy to imagine that, rather than borrowing from UK-domiciled banks, mortgage brokers could arrange for households to borrow from a lender based overseas, or at least with the loan booked overseas. In terms of the accumulation of debt in the sector concerned – in this hypothetical case, housing – there might, after a time, be little or no effect. That would obviously not be great for the risk of default by the borrowing sector concerned. But UK-based banks would have been required to build their defences. That might mean that, other things being equal, if and when the borrowing sector got into difficulty, UK-based banks would be less likely to collapse under the strain of losses. If so, the damage to financial stability would be reduced, and the eventual economic costs might plausibly be lower than otherwise; especially if those UK banks were able to take up some of the slack created by withdrawal of credit supply by foreign banks to sound UK borrowers. It might, though, just be possible to go further.