In the fourth quarter of 2008 and the first quarter of 2009, global economic activity recorded its weakest performance in decades. Today, the situation has improved very significantly. The unprecedented global policy response has had its intended effect. The financial system is showing clear signs of stabilization. Incoming economic data over the last couple of weeks suggest that global economic activity is improving. The economic rebound in the coming months may even exceed expectations. At the same time, looking beyond the near term horizon, our economies and the financial system continue to face considerable uncertainties and challenges. Yet, certain parts of the financial industry appear tempted to go back to business as usual. Industry statements and comments made by some banks on regulatory reforms reflect this trend. Ladies and Gentlemen, I am deeply convinced that it is our common responsibility and duty not to let this happen. Let me begin by laying out three hopefully compelling reasons why we must secure fundamental regulatory reform of the financial sector. The first reason is that too much of the risk taken in the financial sector ultimately resides with taxpayers. The rescue of significant parts of the global financial system from nearcertain collapse by public authorities came at very substantial risk and costs to taxpayers.
If shareholders know that they have to absorb potential  2  Barry Eichengreen and Michael D. Bordo: “Crises now and then: What lessons from the last era of financial globalization?”, NBER working paper 8715, January 2002. 3  “Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience”, April 2008, and the recommendations and principles to strengthen financial systems that the FSB published on 2 April 2009. 2  BIS Review 115/2009  future losses rather than passing them on to taxpayers, they will likely become less willing to let management engage in excessively risky activities. Ultimately, this incentive effect can help make future crises less likely. Strengthening capital requirements The crisis has nakedly exposed the dangers of excessive leverage. It also revealed a number of fundamental weaknesses of existing capital requirements. While model-driven risk-weighted capital requirements are sensible and should be maintained, they are not perfect and very likely never will be. Most of us have had to learn the hard way that the modeling of risk involves substantial risks itself. Despite risk-weighted capital ratios that in most cases exceeded the regulatory minima, leverage was a key source of vulnerability going into the crisis. Excessive leverage not only intensified the impact of mistakes on the financial situation of individual banks. It also amplified the crisis as ongoing deleveraging in the industry inevitably put downward pressure on financial markets and on the real economy. It is now also clear that banks were undercapitalized at the start of the crisis.