•  Introduction of rules that ensure the conservation of capital during times of economic and financial distress. •  Imposition of higher capital requirements for systemically important institutions. •  Development of efficient forms of capital. In particular, contingent capital debt instruments that are convertible into common equity if a bank’s share price were to fall precipitously. Capital requirements with improved risk capture The recent financial crisis has shown that parts of the regulatory capital framework were not calibrated properly to account for the most complex instruments. Our efforts to revise the capital rules should emphasize the need to include these and other risks that were not appropriately captured in recent years. In many circumstances, an emphasis on improved risk-capture may be superior to simply raising the capital requirements across the board. There are two reasons for this. First, it may better tie capital to the risks being undertaken. This, in turn, would create more appropriate incentives for risk-taking. Second, it may reduce the risk of regulatory arbitrage. If the risks of some activities are not captured properly, then banks will have incentives to shift their business toward those particular activities. The Basel Committee has made very good progress in revising the capital treatment of trading book positions and for structured credit products – two areas where the crisis revealed critical weaknesses in the regulatory capital regime. Revisions to the capital requirements for over-the-counter (OTC) derivatives exposures as proposed by the Obama administration also strike me as appropriate.

By forcing all of the banks that participated in the SCAP to have sufficient capital to help them withstand a stress environment, this process improved confidence and increased the willingness of banks to engage with each other. It also made it easier for the banks to be able to tap the capital markets. The SCAP exercise made a bad state of the world less likely, helping to create a virtuous circle rather than a vicious one. The SCAP exercise was developed and conducted in response to the crisis and a specific need. Now, we need to figure out how to conduct these types of exercises on a systematic basis. Such exercises may even need to be hardwired into the supervisory oversight of the financial system. Transparency In some critical segments of our financial markets, both before and during the crisis, limited or ineffective disclosure undermined market discipline and this contributed to the accumulation of risk. In the years leading up to the crisis, the lack of transparency contributed to increased risk and leverage in off-balance sheet vehicles, structured credit products and in over-the-counter securities such as asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) and their associated derivatives. Once the crisis was underway, the opacity of many of these vehicles, structures and securities contributed to the concerns about counterparty credit risk. This uncertainty exacerbated the erosion in market liquidity conditions and further intensified the crisis.