Confronted with against-efficiency regulations, financial markets started to seek ways out. This is a lesson we should keep in mind. II.2. The ‘70s and beyond  These ways out primarily took the form of the emergence of competitors to the US dollar as a settlement currency, the collapse of the Bretton Woods system and the establishment of international syndicate banks which began in 1964. Under the pressure of market forces, starting in the `80s, financial sector deregulation gained ground by loosening up legal and administrative restrictions. Almost all restrictions imposed up to the ‘60s were removed. A new era dawned, with markets enjoying more freedom. One important result worth mentioning is that lending was no longer constrained by the volume of deposits or holdings of liquid assets. Banks could borrow on the interbank market at any time. Under the new circumstances, capital became the only factor containing the size of banks’ books (Goodhart, 2010). Setting appropriate requirements for bank capital was challenging to regulators and it remained so. On the one hand, a strong capital base is associated with the soundness of a bank. On the other hand, that comes at a price in terms of profitability. Capital adequacy requirements were unified under the Basel I Accord, which set them at 8% and established risk coefficients. But they were quickly watered down by the Basel II Accord, which allowed banks to assess their own risks, through sophisticated models. 2  BIS central bankers’ speeches  Starting with the ‘80s, credit expansion was relatively rapid.

The experience until the ‘60s  One of the main conclusions reached in the aftermath of the Great Depression was that competition in the banking sector could jeopardise financial stability. By putting downward pressures on profit margins, competition stimulates banks to take on new risks, thus reducing capital buffers. Consequently, for the following four decades, until the late ‘60s, many measures were aimed at controlling competition. Particularly, limits were imposed on lending and deposit rates, on loans to the private sector, on main monetary variables (which are nowadays set by credit institutions). Likewise, worldwide restrictions were in place on cross-border capital flows and foreign exchange markets. Note also that back in those days commercial banking was separated from investment banking (Glass-Steagall Act) and there was no financial innovation. In addition, policy rates were set by governments. Commercial bankers were paid well (but not remarkably well compared to other professionals) and the 3:6:3 rule accurately described their daily routine: borrow at 3%, lend at 6% and be on the golf course at 3 p.m. In such a “risk-free” environment, capital requirements began to be eased, reaching 5% of bank assets. Extended liability was replaced by limited liability. During 1945–1971 no major banking crisis occurred (Eichengreen and Bordo, 2003), but this came at the cost of lower profitability of banks, whose capacity to innovate and support the economy went down. But, as Andrew Crockett (2011) put it, facilitating informed risk-taking, the financial system is a key element in achieving optimal levels of productivity growth and rising living standards.