Supervisors will have the responsibility to review firms’ compensation policies and structures with institutional and systemic risk in mind and, to apply corrective measures, such as higher capital requirements, to those firms that fail to implement sound compensation policies and practices. Supervisors would also have the ability to modify compensation structures in the case of firms that fail or require extraordinary public intervention. 33. As I already alluded to, supervisors should pay a major attention to financial firms’ governance. As it stands, prudential regulation to a large extent is build on trust in their ability to value, manage and control their risks. Supervisors should have the power to hold boards responsible for the performance of their institutions. They should ensure that boards and individual directors are sufficiently empowered and informed to understand and to respond appropriately to their risk taking policy. 34. In light of the crisis, proper liquidity risk management should also stand high in firms’ own agenda. In many respect, the recent crisis revealed wrong liquidity pricing and poor liquidity risk valuation by financial firms. There is ample evidence that in an environment of excess global liquidity prior to the recent crisis many financial institutions were led to (i) overestimate the liquidity of their assets, (ii) have overly optimistic assumptions on their ability to refinance, and (iii) ignore, or pay insufficient attention to, liquidity risks in their internal pricing processes. 35. One should never forget that liquidity has a price.

The challenge, now, is to calibrate and phase in the new framework in a way that does not impede the recovery. The macroeconomic assessment of the reforms underway will help us strike the optimal balance. 25. Beyond capital and liquidity, other important initiatives are aiming at addressing systemically important financial institutions and cross-border resolutions. To better deal with the problem associated with systemic firms, progress is being made to improve the capacity to resolve them orderly, and to strengthen ex ante preparedness, contingency planning, cooperation and information exchange among the relevant authorities. 4  BIS Review 113/2010  26. There is a broad agreement for an approach that may have two pillars. One is about tools and measures to limit the risk of their failure; the other is about tools and measures to limit the consequences of their failures. Discretion is required to allow national authorities to strike the balance between the two pillars and tailor regulatory and supervisory actions to domestic conditions. The challenge is to ensure that national policies to address the risks associated with these firms are consistent, mutually supportive and thus avoiding regulatory arbitrage. But beyond international initiatives, enhancing supervision at the domestic level remains very critical. 27. Higher and better capital and liquidity standards are not sufficient conditions to secure the stability of the financial sector. Changes in the practice of micro-prudential oversight are also needed. Indeed, a lesson from the crisis is that the way supervision was performed prior to the crisis has likely contributed to it.