Yet it also introduces distortions into resource allocation that may prove costly. Accordingly, ahead of any regulatory proposal it is more than advisable to assess the scope of these distortions. The book, in various chapters, correctly identifies potential adverse effects of what is categorically referred to as a “regulatory tsunami” or even, as one author puts it, a “regulatory orgy”. The text broaches the possibility that the pace and scope of regulatory change might be affecting the liquidity of certain securities markets and also risk-taking by relatively unsupervised sectors, and may be reducing banks’ loan-granting capacity or lessening competition, among other developments. The authors rightly suggest that the reasonableness of the changes, their parameterisation and their implementation schedule must be properly evaluated taking into account not only their direct contribution to financial stability but also possible side-effects. One idea intimated in the analysis is that, given the risks over-regulation entails, an alternative approach might be to economise on regulatory changes and to increase supervisory intensity instead. That is to say, there should be an attempt to contain the avalanche of new regulatory requirements applicable across the board, replacing some of them with intrusive supervisory measures, adapted to each bank’s specific situation. This is admittedly a very attractive idea which I would like to explore in the rest of my speech. Supervisory challenges Until recently, core supervisory actions in many jurisdictions had focused, perhaps excessively, on the surveillance of banks’ solvency through the monitoring of capital ratios as defined under current regulations.

It is nevertheless true that the implementation of Basel Pillar 2 on the basis of the regular supervisory review exercises has somewhat changed the situation. Pillar 2 allows specific requirements to be made of each bank on the basis of its risk profile so as to cover aspects not contained in Pillar 1 (minimum regulatory capital ratios). In that way the supervisor can regulate solvency requirements by adjusting them to each bank’s situation, thereby  BIS central bankers’ speeches  1  extending the supervisor’s discretion and reinforcing its role, while reducing commensurately the relative significance of the general solvency requirements set in the regulations. Likewise, the inclusion of stress tests as a supervisory tool extends the supervisor’s capacity to impose capital requirements or other constraints on banks when this is necessary to withstand adverse scenarios, even if such scenarios are rather unlikely. Once again, this tool broadens the weight of supervisory action. That said, in order to optimise the scope of supervision, supplementary instruments – that are not always available in accordance with the prudential regulations in force – are needed. For instance, not in all jurisdictions must the supervisor expressly authorise the eligibility of certain capital instruments, the acquisition of qualifying holdings in other financial institutions or dividend pay-outs charged to reserves. Above all, effective supervision should occasionally be based on discretionary actions rather than mere application of the instruments expressly provided for under the regulations.