The most narrow definition of capital,4 tangible common equity, is a measure of capital widely used by investors (and increasingly so during the crisis) because it focuses on the “core” capital readily available to cushion the bank against losses. The tangible capital measure – specifically the ratio of tangible common equity to tangible assets – was a bit above 2 percent for Wachovia and about 3 percent for WaMu,5 providing only a small cushion against the losses accumulating from their subprime exposures. The regulatory capital ratios use broader definitions of capital, relative to risk-weighted assets. To be considered adequately capitalized, a bank needs to have at least 4 percent Tier 1 risk-based capital to risk-weighted assets, and at least 8 percent total risk-based capital to risk-weighted assets. To be well capitalized a bank needs to have at least 6 percent Tier 1 risk-based capital to risk-weighted assets and at least 10 percent total riskbased capital to risk-weighted assets.6 Figure 1 shows that under these definitions both banks were well capitalized in their final quarter – despite the fact that more narrow definitions of capital indicated only a very small capital buffer. Figure 2 plots the capital ratios for the period leading up to the “run” on Wachovia. The broader definitions of capital – Tier 1 and total risk-based capital – were actually rising in the period when holders of Wachovia’s liabilities were becoming concerned, and thus the broader definitions of capital were not particularly informative.

Such transformation will result in a shift in relative prices (away from carbon-based technology), influence the patterns of consumption and production (towards non-carbon, carbon-efficient, and carbon-capture technology), and redirect the financial resources to support the process. As I noted earlier, being a service industry, the financial sector will need to adapt by managing risk, developing supportive financial services, and exploring business opportunities. Both the threat and the opportunities that emerge will be a challenge for all segments of the financial system i.e. insurance, banking, and fund management. In this process, awareness, right incentive, and market mechanism will be key in determining the pace of change. Third, the financial sector can also be an agent of change, because of the three important roles it can play. Firstly, it can directly influence resource allocation by internalizing climate change in its core business decisions i.e. lending, investment, and fund management. Secondly, it can indirectly influence resource allocation by developing supportive financial services, markets, risk management and investment products that assist the adaptation process, for example, through the development of insurance products, weather derivatives, and “CAT”-bond, and also assist the mitigation process through trading of carbon credits and allowances. The scope for business opportunities on these two fronts are many, and are open for all segments of the financial system, ranging from commodities services to corporate finance, to investment banking, and retail banking. And thirdly, financial institutions can also engage climate change in its business agenda as part of the corporate social responsibility (CSR).