This "credit equivalent amount" is approximately 175 percent of tier-one capital, about 15 percent higher relative to capital than five years ago. This measure of the underlying credit exposure in OTC derivatives positions is roughly a fifth of the aggregate total credit exposure of the largest bank holding companies. This is a relatively conservative measure of the credit risk in total derivatives positions, but, for credit derivatives and some other instruments, it still may not adequately capture the scale of losses in the event of default in the underlying credits or the consequences of a prolonged disruption to market liquidity. The complexity of many new instruments and the relative immaturity of the various approaches used to measure the risks in those exposures magnify the uncertainty involved. •  Internal risk management systems have improved substantially since the mid-1990s, but most firms still face considerable challenges in aggregating exposures across the firm, capturing concentrations in exposures to credit and other risks, and producing stress testing and scenario analysis on a fully integrated picture of exposures generated across their increasingly diverse array of activities. The greater diversity of institutions that now provide demand for credit risk, or are willing to hold credit risk, should make credit markets more liquid and resilient than would be the case if credit risk was still held predominantly by banks or by a smaller number of more uniform institutions, with less capacity to hedge those exposures.

At the same time, we must ensure that banks, especially the larger ones, go back to their core business of extending credit to the real economy and refrain from engaging in the kind of risk-taking that gave rise to the recent crisis. Priority must, therefore, be given to the one measure that is most likely to influence the banks’ ability to take risk, that is the BCBS proposals on bank capital. Capital buffers must henceforth be commensurate with the degree of risk undertaken. It is no longer acceptable that profits are privatised and losses socialised. In a broader context, another important challenge is to ensure that systemic risks are addressed without unduly constraining financial innovation and integration. Finally, the opportunity provided by the current period of reflection should also be used to examine the possible consequences of some of the reform proposals for the functioning of financial markets and for the implementation of monetary policy, and by extension also for the real economy. References 1. European Central Bank, The Incentive Structure Of The “Originate And Distribute” Model, 2008. 2. Francis Boyer Lecture of The American Enterprise Institute for Public Policy Research, “The Challenge of Central Banking in a Democratic Society”, 1996. 3.  http://www.reuters.com/article/idUSN0132320120071003  4. The High-Level Group on Financial Supervision in the EU, 2009. BIS Review 67/2010  3  5. Basel Committee on Banking Supervision, “Strengthening the resilience of the banking sector”, 2009. 6. Basel Committee on Banking Supervision, “International framework for liquidity risk measurement, standards and monitoring”, 2009. 7.