In setting quotas, no account was taken of interactions between species and the surrounding eco-system. During this century, fisheries management has pursued a different strategy – Ecosystem-Based Fishery Management (EBFM). 32 EBFM takes as its starting point the management of the eco-system. It develops system-level standards and single-species targets are calibrated to ecosystem-wide objectives. The EBFM approach is already being implemented in Alaska, California and the Antarctic. Existing regulatory rules for financial institutions have echoes of fisheries management in the 1970s. Risk quotas are calibrated and applied node by node, species by species. This approach takes no account of individual nodes’ system-wide importance – for example, arising from their connectivity to other nodes in the network or their scale of operations. Charts 8 and 9 illustrate the problem. They plot the relationship between global banks’ capital ratios and their size, where size is used here as a rough proxy for connectivity and scale. Chart 8 shows there is essentially no relationship between banks’ systemic importance and their Basel capital ratios. There has been no targeted vaccination of the super-spreaders of financial contagion. Chart 9 uses leverage ratios rather than risk-weighted Basel capital ratios. It suggests that, if anything, the super-spreaders may historically have had lower capital buffers. One potential explanation of these findings is that large banks have benefited from the diversification benefits – those words again – of Basel II. Another is that financial markets have allowed these banks lower capital buffers because of the implicit promise of government support.

Cumulative returns earned by, on the face of it, very different financial models illustrate this story (Chart 7). Looking across global banks, large complex financial institutions (LCFIs), insurance companies and hedge funds, cumulative returns have exhibited a remarkably similar pattern, both in the run-up to crisis and in the subsequent run-down. Rolling averages of pairwise correlations across sectors averaged in excess of 0.9 throughout the period 2004-2007. At the height of the credit boom, financial imitation appears to have turned into near-cloning. Flattery gave way to fat-cattery. What was true across financial sectors was also true within them. For example, hedge fund strategies rejoice in such oblique names as “convertible arbitrage” and “dedicated short bias”. The average pairwise correlation between these different funds’ strategies was roughly zero at the turn of the century. By 2008, it had risen to around 0.35. Far from daring to be different, hedge funds seem increasingly to have hunted as a pack. 19  Worm et al (op.cit.). 20  Levin and Lubchenco (2008). 21  For example, Tilman (1999) and Clay (2004). 10  BIS Review 53/2009  Management of the risks resulting from these strategies amplified this homogeneity. Basel II provided a prescriptive rule-book ensuring a level playing field. Ratings were hard-wired into regulation. Risk models blossomed, with Value-at-Risk (VaR) and stress-testing providing seductively precise outputs. Like blossom, these models looked and acted alike – and may yet prove similarly ephemeral.