The new structure of bank capital regulation will comprise three core elements: First, a foundation of loss absorbing capacity, designed to absorb losses when banks fail so that resolution can take place without taxpayer support or huge damage to financial systems and the wider economy. Second, a central structure of going concern capital requirements, with significant reforms to improve quality and quantity. And third, capital buffers forming a protective roof against rainy days, with higher buffers for systemically-important firms, whose distress would do the most damage, and macroprudential authorities able to increase buffers counter-cyclically when they see storm clouds gathering. In the UK, as in other jurisdictions, we will also use more than one approach to assess the robustness of this structure – with different approaches likely to bind on different firms, depending on their business models, at different times. First, the internationally-harmonised Basel risk-weighted ratio, intended to be risk sensitive and, in our view, with some continuing role for firms’ internal models where we can be confident that they make use of firms’ internal information to improve risk sensitivity in a robust way. That debate continues internationally. Second, the leverage ratio, which weights assets equally as a safeguard against errors in ex ante estimates of risk and prevents excessive balance sheet stretch. In the UK, the Financial Policy Committee (FPC) has recently announced its plans for leverage ratio requirements and buffers.

Capital markets could go through a process of progressive and partial fragmentation: no significant capital account opening would occur in many parts of the world. Conversely, new barriers could be erected either in the form of “soft” capital controls or through national regulations forcing financial institutions to ring‐fence local pools of capital and liquidity. There would be little convergence in domestic financial systems and regulations. Foreign exchange reserves would keep growing, both in absolute terms and as a percentage of world GDP. This scenario may be seen as the only realistic response to increased diversity in a multipolar world. The systemic consequences, however, are not clear. In such a world,  BIS Review 127/2010  3  current account imbalances would be heavily influenced by public actions and policies. Regulatory competition would determine the location of financial activities and the allocation of savings. In the absence of some “rules of the game”, tensions would naturally arise between countries regarding many aspects of their domestic and international macroeconomic policies. The opposite scenario would involve the progressive opening of all capital accounts, together with some (more or less intensive) convergence in financial systems and regulations. This would allow for the emergence of a unified world capital market, an efficient allocation of savings across countries and a smooth financing of current account imbalances. Experience shows, however, that an open international financial system is not inherently stable and, therefore, very dependent on strong infrastructure. Two elements of such an infrastructure seem especially important.