Structuring a long-term debt requirement so that a meaningful component consists of deferred compensation held by senior management would presumably strengthen the incentives for proactive risk management. In my opinion, more research is needed into how the structure of management compensation for financial firms could incentivize good risk management and limit the appetite for excessive risk.1 Even if every jurisdiction were to successfully implement these types of initiatives and consequently reduce the default risks associated with their G-SIFIs, the risk of failure would not be fully eliminated. This means there would always be some residual risk of major disruptions to financial markets due to a disorderly default of a large financial firm. Consequently, the development and implementation of credible resolution mechanisms for G-SIFIs is the second key component of a global strategy to improve financial stability. By credible, I mean that if the situation of an impending G-SIFI default arises, the home authorities will proceed with the resolution plan, rather than give in to pressure to intervene to prevent the failure. This requires that the resolution mechanisms be capable of significantly mitigating the negative externalities associated with winding down a failing G-SIFI. Although the specifics of the resolution mechanisms will necessarily vary to some extent across jurisdictions, reflecting differences in institutional structures, legal frameworks, and regulatory regimes, the goal is common – to be able to resolve any G-SIFI regardless of its home  1  Structuring this in a way to get the incentives right is critical.

Third, we need to strengthen the resiliency of our financial system so that the stresses associated with the failure of a major financial firm are not amplified across the system. Fourth, we need to build up our data capabilities so we can better monitor the global financial system as a whole. For the full benefit from this multifaceted approach to be realized, public authorities must continue to work together in a coordinated manner. Global, systemically important financial institutions (G-SIFIs) pose a significant challenge to financial stability on two fronts. First, due to their size, complexity and central role in financial markets, a disorderly failure of a G-SIFI would directly cause major disruptions in markets, adversely affecting credit flows and real economic activity. Second, such a disorderly failure  BIS central bankers’ speeches  1  would also indirectly place significant negative strains on other financial firms due not only to direct credit exposures to the failed institution, but also due to the fire sale dynamics that would ensue. The lack of transparency in markets as to which firms would be most affected could result in a general pull-back by investors, which, in turn, could lead to additional deleveraging and further downward pressure on asset prices. As we saw during the financial crisis, this amplification mechanism could quickly spread the strains throughout the global financial system. Prior to the financial crisis, the risk to financial stability posed by G-SIFIs created a dilemma for policymakers when one or more of these firms found itself in danger of failing.