One of the fundamental tenets of risk management is that banks need to create provisions to absorb expected losses and to have sufficient capital to absorb unexpected losses. Accordingly, capital and provisions are an essential part of any supervisory framework. I believe Basel II reinforces the need to implement sound policies in both areas. In this respect, it is important to analyse provisions and capital over at least one complete economic cycle. Moreover, a range of potential future scenarios, with an emphasis on stress scenarios, should be considered, taking into account past experience and current conditions. Indeed, Basel II requires banks adopting the more advanced approaches to credit risk to apply a forward-looking approach to credit risk management by meaningfully stress testing their credit portfolios. Gaining room for manoeuvre and shoring up finances during good times in the business cycle is not only prudent policy, but is also consistent with sound risk management. Many would say that risks increase during bad times, but I believe this is only partly true. In my view, the exposures of banks, and therefore their risks, actually increase during economic upturns. These risks may not materialise until times of difficulty, but the seeds are generally planted during good times. In sum, when designing their capital and provisioning strategies, managers should have the aim of strengthening banks during good times and should remember that the imbalances that foster financial instability usually build up during the best parts of the economic cycle.

Finally, both big banks are in the process of finalising their Swiss emergency plans, in which they have to demonstrate that they would be able to maintain their systemically important functions without interruption in a crisis. Credit Suisse and UBS have taken important measures in this context over recent years. For instance, they have both established Swiss subsidiaries to house their systemically important functions. According to FINMA, further efforts by the big banks are required to ensure their plans are finalised by the statutory deadline of end-2019. 1 Domestically focused banks  I would now like to turn to the domestically focused banks. The mortgage and real estate markets remain the biggest source of risk for these banks. Imbalances persisted on these markets in 2018. Both mortgage lending volume and prices for single-family houses and privately owned apartments continued to rise at a moderate rate in 2018. In the residential investment property segment, transaction prices fell slightly in 2018. Nevertheless, the risk of a price correction in this segment remains particularly high. On the one hand, this is due to strong price increases in previous years. On the other, the further rise in the number of vacant dwellings suggests that the brisk construction activity in rental apartments may have led to an oversupply. The risk appetite of domestically focused banks in this environment remained high. Mortgage growth at these banks continued to be robust at around 4.2% last year. Banks’ current lending policy in the residential investment property segment should be viewed as particularly risky.