we can turn this crisis to our long - run advantage by reviewing and reforming the structure and regulation of banking. as sir walter scott noted, the failure of the ayr bank in 1772 “ was a terrible [ warning ], and has been so well attended to in scotland … forcing a capital on the district could only lead to wild speculation, instead of supporting solid and promising undertakings ”. of the bankers themselves, scott recognised that, while the majority were “ good men ”, “ there may have been, among so numerous a body, men of a different character, fishers in troubled waters, capitalists who sought gain not by the encouragement of fair trade and honest industry, but by affording temporary fuel to rashness or avarice ”. if unsustainable capital flows provided the fuel and an inadequately designed regulatory system ignited the fuel, the past two years have shown how dangerous it is to let bankers play with fire. this is not a question of blame – as sir walter rightly said, the majority in the industry are “ good men ” and women. it is a matter of the incentives they face. to protect our genuinely successful financial centres – of which edinburgh is clearly one – reform of banking is essential. with that, i am confident that we will have attended to our terrible warning and our varied and internationally competitive financial services industry will thrive.

causes of the crisis, then we shall bequeath to future generations a serious risk of another crisis even worse than the one we have experienced. tonight i want to focus on the second of those challenges – reform of the structure and regulation of the banking system. why were banks willing to take risks that proved so damaging both to themselves and the rest of the economy? one of the key reasons – mentioned by market participants in conversations before the crisis hit – is that the incentives to manage risk and to increase leverage were distorted by the implicit support or guarantee provided by government to creditors of banks that were seen as “ too important to fail ”. such banks could raise funding more cheaply and expand faster than other institutions. they had less incentive than others to guard against tail risk. banks and their creditors knew that if they were sufficiently important to the economy or the rest of the financial system, and things went wrong, the government would always stand behind them. and they were right. the sheer scale of support to the banking sector is breathtaking. in the uk, in the form of direct or guaranteed loans and equity investment, it is not far short of a trillion ( that is, one thousand billion ) pounds, close to two - thirds of the annual output of the entire economy. to paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. and, one might add, so far with little real reform. it is hard to see how the existence of institutions that are “ too important to fail ” is consistent with their being in the private sector. encouraging banks to take risks that result in large dividend and remuneration payouts when things go well, and losses for taxpayers when they don ’ t, distorts the allocation of resources and management of risk. that is what economists mean by “ moral hazard ”. the massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. the “ too important to fail ” problem is too important to ignore. there are only two ways in which the problem can – in logic – be solved. one is to accept that some institutions are “ too important to fail ” and try to ensure that the probability of those institutions failing, and hence of the need for taxpayer support, is extremely low. the other is to find a way that institutions can fail without imposing unacceptable costs on the rest of society