In exchange for being allowed to profit from taking the risks inherent in providing liquidity, or monetary and credit, services to the economy, banks have been subject to prudential regulation; given access to liquidity insurance at the central bank; and required to finance industry-wide insurance schemes to protect depositors. All three components have needed to be redesigned. I offered a few thoughts on the first – the regulation of banks – at the conference on the FSA’s Turner Report a few weeks ago. On microprudential supervision. I wanted to add four  BIS Review 83/2009  1  points. First, that supervisors must be expert, unafraid to substitute their judgment for that of management and the board where necessary, but restrain themselves from doing so except when needed. Second, that concentrated exposures, on either side of the balance sheet, must be limited. Third, that complex structures rendering a bank unsupervisable must not be permitted, as the BCCI crisis taught us nearly twenty years ago. And fourth, that regulatory requirements for capital, liquidity and so on should take into account how much risk a bank brings to the system as a whole. As one of my predecessors, George Blunden said over twenty years ago, “Supervisory standards are set with an eye to protecting [banks] from problems which could be created by wider, systemic developments. A bank may consider a course of action it wishes to take to be acceptable – as it may well be in a limited context.
I hope that the Financial Stability Board Working Group on the Crisis Management Principles will not hesitate to report back to the FSB, and through it to alert G20 Ministers, if implementation is or looks to be stalling – whether because it is meeting with resistance from the authorities or the industry, or blockages in national laws and practices. 8  BIS Review 83/2009  Concluding comment This crisis has reminded a generation of some old truths. Banks can fail. But they matter enormously to our economies, and so the authorities cannot afford to stand back and allow disorderly systemic failure. Going forward, we cannot have a regime where the upside for risk-taking goes to shareholders and management, but the downside falls to the general taxpayer. All three elements of the Social Contract for banking need to be reformed. Better regulation and supervision, including a macroprudential element. Better arrangements for liquidity insurance, which the Bank has tried to introduce alongside our international peers. And, my main topic today, a new regime for resolving bank distress. In particular, banks must structure and run themselves to permit orderly wind down. And they must invest to provide the authorities with the information they need to do so. This will not be easy. And it will not be cheap. Together with higher capital and liquidity requirements – lower leverage and reduced maturity transformations – over time it may well mean a lower headline return on equity for some banks.