In the UK we have also set out proposals to reform the legal framework for dealing with failing banks. Through the Financial Stability Forum we also need to strengthened supervisory colleges and cross-border crisis management arrangements. One more general lesson is that we have to recognise the difference between what is good risk management in a single company and what is good for the system as a whole. For a company the ideal risk management system is one which enables them to take risks, reap the rewards but get out first when the music stops. And the right capital and liquidity is one which is just enough to see you through the subsequent downturn in asset prices and transactions. But there is always someone at the end of the queue and it is impossible to be sure who they will be. Moreover in a global market the problems of one institution are bound to spread quickly to others along a complex web of interconnections in many markets. For the authorities what matters is whether the losses to the slower players damage the system as a whole. One lesson of recent events is that the capital and liquidity buffers need to be  BIS Review 114/2008  5  higher for everyone. The long decline in holdings of liquid assets (Chart 8) by banks for example has to be reversed a bit and the increase in leverage likewise (Chart 9).

Chart 1: Commodity Prices  Chart 2: CPI Inflation Percentage points 5  Index: Jan. 2007 = 100 300  Energy Food and non-alcoholic beverages CPI (per cent)  Brent oil price Wholesale gas price  250  4  Economist food-price index 200  3  150  2  100  1  50  0  0 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08  6  -1 2004  2005  2006  2007  2008  BIS Review 114/2008  Chart 3: Inflation expectations  Chart 4: Three month Libor spreads  Per cent  5 5-10 years ahead [YouGov/Citigroup]  4 3  Basis points Sterling  180  Euro  160  US dollar  140 120 100  2 12 m onths ahead [Bank NOP]  12 m onths ahead [YouGov/Citigroup]  80 60  1  40  0 2003  2004  2005  2007  20  2008  0 Jan Mar May Jul 2007  Chart 5: Credit conditions on mortgage lending  Sep Nov Jan Mar May Jul 08  Sep 09  Chart 6: Feedback effects (I)  Net percentage balances(b) Factors contributing to 60 changes in credit availability  Credit availability  Changing economic outlook  Changing cost/ availability of funds  Weaker growth and falling house (and other collateral ) values  40 20 + 0  (3)  -  20 40  Bank losses (1)  Tighter credit conditions (2)  60 Q2  Q4 2007  Q2 08  Q2 Q4 Q2 2007 08  BIS Review 114/2008  Q2 Q4 Q2 2007 08  7  Chart 7: Feedback effects (II) Higher funding costs  Deterioration in the property market  Falling house prices  Increase in loss given default  Increase in credit losses  Squeeze on net interest income Erosion of capital ratios  Macroeconomic slowdown  Increase in default  Scarring effect on capacity  Increase in risk weights  Regulatory minima  Pressure to deleverage  Higher income gearing Tighter credit conditions  Chart 8: Liquid assets ratio  Chart 9: Leverage ratios of major UK banks P e r c e nt a ge of  35%  t ot a l a sse t s (all cur rencies)  30%  Maximum-minimum range Interquartile range Median  Ratio 65 60 55  25%  50 45 40 35 30 25  20%  15%  10%  5%  1967  1972  1977  1982  1987  1992  1997  2002  Liquid asset s inclues: Cash, BoEbalances, money at call, eligible bills and UK gilt s.  8  20 15 10  0% 2007  97 98 99 00 01 02 03 04 05 06 07 08  BIS Review 114/2008