Jean-Pierre Landau: Complexity and the financial crisis Introductory remarks by Mr Jean-Pierre Landau, Deputy Governor of the Bank of France, at the at the Conference on “The macroeconomy and financial systems in normal times and in times of stress”, jointly organized by the Bank of France and the Deutsche Bundesbank, Gouvieux-Chantilly, 8 June 2009. *  *  *  I am very pleased to welcome you to this second Banque de France-Bundesbank Conference on “The Macroeconomy and financial systems in normal times and in times of stress”. Actually, the distinction between normal and stress times may be somehow misleading. It is of course fascinating and extremely useful to study the behavior of financial systems under stress. But, from a policy perspective it is essential to recognize that the seeds of instability are sown in normal times. The crisis has shown that public authorities have very limited options in stress times but to keep the system afloat at all costs. This involves rescuing financial institutions whatever previous commitments have been previously made not to do so. Indeed, the doctrine of moral hazard may be one of the most prominent and lasting casualties of the crisis. So, collective efforts should mainly concentrate on detecting those features of financial systems which, even in (apparently) normal times create or amplify stress. This is the essence of the macro prudential approach to financial supervision. One of its main challenges is to grasp and deal with the full complexity of contemporary financial markets and institutions. Financial systems are complex systems.

Overall, complexity may have resulted in more fragility, an evolution already foretold by Minsky who saw structural changes in financial systems over time as an essential cause of their vulnerability Complexity has deep implications for public policy and the future of financial regulation. •  First, about transparency. Improving transparency is the first item on the G20 international agenda, for financial regulation reform. Transparency is normally considered as a prerequisite to the existence of efficient financial markets. More recently, full transparency on aggregate positions and exposures by main financial intermediaries tends to be seen by financial supervisors as necessary to assess potential systemic risk. However, when the system is constantly morphing into new structures, and permanently changing networks, a comprehensive, but static vision may prove inadequate, because it will not eliminate the uncertainty stemming from the potential discontinuities embedded in market dynamics. What is needed, at least,  2  BIS Review 95/2009  is an overall understanding of the complex dynamics at work, which may be better reached through a permanent reexamination of their structure and constantly testing against very adverse circumstances. •  Second, robustness. A natural reaction to financial fragility is to strengthen the ability of financial institutions to withstand shocks by increasing their capital and liquidity requirements. While necessary, it is doubtful whether this "buffer" approach will help when uncertainty settles in. Then, the net demand for both liquidity and capital becomes infinite, because gross demand is unknown and hoarding creates little or no supply.