That might not matter were the consequences limited to the party-goers. But they are not. When the party ends, some innocent bystanders may lose their homes altogether. Moreover, the party-goers aren’t just deposit-taking banks. A wide range of financial institutions, including investment banks, monoline insurers, even hedge funds, have the potential to cause significant damage to the rest of the economy in the wake of their demise. Are they all to be helped to get home safely when the party ends? If so, will they all be regulated in the same way as banks? If not, how can we limit the potential cost to the taxpayer? Add to this the problem that many of these institutions are global in scope, but the responsibility for both regulation and rescue remains firmly at national level, and you can see why policy-makers get headaches as bad as the party-goers’. No individual bank, or indeed the authorities, can easily find a way out of this because their incentives are to continue in the same manner. There is, therefore, no point blaming anyone for the outcomes. But together we have to find an answer. Of course, excessively strict and detailed regulation would mean that there were no parties worth going to and the economy as a whole would suffer from a suppressed and inefficient financial sector.
The prize will be an integrated framework, covering all our lending to the banking system and one that I hope, by making clear the terms on which liquidity will be provided in times of stress, will focus the minds of banks long before those stresses emerge. During my second term as Governor I would like to see us establish a framework for financial stability that is on as sound a footing as the one we have successfully established for monetary stability. The measures I have described would go a considerable way to achieving that. But just as no framework for monetary policy can prevent shocks from hitting the UK economy, we need to think carefully about why financial crises have been both persistent and damaging. That leads me to one final thought on which I want to end. For reasons of historical accident we have created over many decades a financial system in which the incentives to monitor risk-taking have been sharply reduced. It is often said that the role of a central bank is to take the punch bowl away just as the party is getting going. That approach has served us well in monetary policy. But all those efforts will come to naught if the opposite applies to the financial sector. If banks feel they must keep on dancing while the music is playing and that at the end of the party the central bank will make sure everyone gets home safely, then over time the parties will become wilder and wilder.