In theory, the safety and soundness of a bank should be a key factor for customers in choosing the bank with which they want to entrust their money. Again, in theory a bank with a large capital cushion should (all things being equal) have a competitive edge in gaining customer confidence as compared to other banks with a weaker capital position. This being the case, banks should have an incentive to maintain higher capital levels. However, incentives have become somewhat distorted in more modern times, thanks to formal safety nets extended by deposit protection schemes and informal safety nets characterised by implicit government guarantee arising from the “too big to fail” consideration. 13. In the run up to the Global Financial Crisis, it was common for the big banks to maximise their Return on Equity (RoE) by optimising the level of their capital base and by leveraging up their balance sheets. This resulted in a steady reduction in the levels of capital, and as a result in the loss absorbancy capability, of banks in relation to the size of the risks taken by them on and off balance sheet. Even now, there is still a view amongst some banks that the Basel Accord serves more to indicate “optimal” levels of capital or liquidity rather than the absolute bare minimum standard. Some banks, including a few here in Hong Kong, have argued that the late adoption of Basel III by some advanced economies creates or constitutes an uneven playing field, placing them in a competitively disadvantaged position.
The Basel Committee has done a great deal in upgrading capital and liquidity rules. Under the direction of G20, there is long list of other regulatory reforms, including those dealing with the moral hazard problem arising from “too big to fail” and the risks observed in the OTC derivative markets. Some national authorities have introduced, or plan to introduce, measures that would separate core retail and commercial banking from  BIS central bankers’ speeches  3  investment banking. Although, as I have said, very few people would dispute the need for urgent reforms, there are differences in views on whether the reforms that are underway are indeed adequate or entirely appropriate. 16. I hope that, at tomorrow’s Forum, you will have the opportunity to discuss these and other pertinent issues as we continue seeking to re-evaluate both the nature of risk management and the role of regulation and supervision in the wake of the Global Financial Crisis. Once again let me welcome you all and wish you Bon Appétit! 4  BIS central bankers’ speeches