If these institutions could be resolved easily, so that the systemic consequences of their failure were limited, efficiency considerations could perhaps be set to one side. Or, put in Weitzman’s terms, the social benefits of cutting banks down to size would be low. But crisis experience has demonstrated that the apparatus does not currently exist to resolve safely these institutions. There are no examples during this crisis of financial institutions  38  Laeven and Levine (2007); see also Schmid and Walter (2009) for recent US evidence. 39  Robinson (1934). 40  Christakis and Fowler (2009). 41  Dunbar (1993). 12  BIS Review 40/2010  beyond $ billion being resolved without serious systemic spillovers. 42 Instead, those in trouble have been bailed-out. The same 145 institutions account for over 90% of the support offered by governments during the course of the crisis. In the light of the crisis, and in the language of Weitzman, the marginal social benefits of restrictions could be greater than the marginal private costs. The maximum efficient scale of banking may lie below the maximum resolvable scale. A large part of the effort of the international community over the past few years has been directed at increasing the maximum resolvable scale of banks – for example, through improved resolution regimes and living wills. 43 If successful, that effort would shift the balance of the Weitzman cost/benefit calculus in the direction of bigger banks; it could help achieve the modularity, robustness and better aligned incentives which restrictions otherwise deliver.

By encouraging a dialogue between bankers and supervisors through Pillar 2, the Committee believes that the New Accord will create additional and powerful incentives for banks to exercise care in their internal assessments. But equally important, by agreeing on shared guidelines for supervisory review, we expect that the New Accord will promote greater consistency in the manner in which supervisors apply the capital framework. When supervisors across jurisdictions share similar expectations for capital adequacy, the regulatory burden on banks operating in different jurisdictions can be eased greatly. The third pillar - market discipline - seeks to leverage the influence that other marketplace participants can bring to bear on a bank to manage its risks appropriately. By enhancing transparency in a bank’s public reporting, counterparties, rating agencies, and even customers will have better access to timely  2  BIS Review 12/2004  and meaningful information about a bank’s activities and exposures. They will, in turn, be better able to make business or investment decisions. That will help markets to reward banks that manage their risks judiciously while penalising those that do not. By matching the minimum capital requirements with a robust supervisory review and enhanced financial transparency, the Committee is embracing a philosophy of incentive-based supervision that will encourage banks and supervisors to focus on the quality of their risk management processes. So the basic three-pillar structure of the New Accord is rather simple to explain. The challenge lies in specifying principles and rules for banks and markets of many sizes and shapes.