on sifis. in my view, only globally active institutions should be addressed by an international sifi regime. a pragmatic approach would be to start with a limited number of institutions which are indisputably of global systemic relevance. the financial stability board is currently developing a methodology to accurately define global sifis based on criteria such as size, interconnectedness or substitutability. first results of this exercise are expected by mid - 2011. the outcome, that is the specific members of this group of global sifis, will probably not be much of a surprise. but the issue of how to properly identify systemically relevant institutions becomes increasingly complex and contentious when turning to a lower – for example the national – level and will keep regulators and supervisors busy for some time to come. for this reason, it is a good strategy to focus on the least contentious and at the same time most systemically relevant candidates first. 2. 3 into the light : the shadow banking sector basel iii and special rules for systemically important institutions are certainly important instruments in safeguarding the stability of the financial system. however, the best dike is of little use when there is a whole ocean at your back. this ocean is the so - called shadow banking sector : the part of the financial system that is not subject to regulation, that has been inviting regulatory arbitrage and that has been a significant amplifier of risk during the financial crisis. with stricter rules for the regular banking sector, there is a clear danger that more and more activities will flow around the newly erected dikes and add to the ocean of unregulated activity at our back, thereby increasing systemic risk. thus, we have to turn our heads, take a close look at the shadow banking sector, understand what is going on there and ultimately control the systemic risks that we have identified. as a first step it is necessary to define the shadow banking sector. here, a broad approach is warranted for two reasons. first, the broader the regulatory view, the less room for regulatory arbitrage remains – provided regulation is internationally coordinated. second, only a broad view allows the regulators to keep track of the constant evolution of the shadow banking sector. for the same reasons, it is imperative to define the shadow banking sector not in terms of entities but in terms of activities. the central characteristic of shadow banks is that they replicate the classic activities of banks : they conduct credit transformation, liquidity transformation and maturity transformation. given

individual bank. making this basic element of the financial system more stable will be an important step towards more systemic stability. in essence, there exist two elements of protection for the individual bank, one being capital and the other liquidity. capital serves as a buffer against potential losses, and during the crisis it became obvious that regulatory capital provisions were not adequate. hence, in the future, banks will have to hold more capital of better quality. another major problem during the crisis concerned liquidity. when, after the lehman insolvency, financial institutions stopped lending money to each other, a number of banks experienced severe liquidity shortages. their only remaining options were either to sell assets, thereby disrupting the markets further, or to approach central banks as lenders of last resort. in fact, had the central banks not supplied the financial system with liquidity it would have collapsed. bis central bankers ’ speeches on the basis of these experiences the basel committee on banking supervision ( bcbs ) proposed far - reaching reforms regarding capital and liquidity provisions. these rules, known as basel iii, will make individual banks more stable and will constitute a first line of defence against systemic crises. in november 2010, basel iii was endorsed at the g20 summit in seoul. now, it needs to be transposed into national law and applied without falling behind the agreed timetable. 2. 2 too big to fail : handling sifis basel iii will certainly make banks more stable, but it will never be possible to entirely rule out the failure of individual institutions. thus, a second line of defence is needed to prevent the failure of individual banks from triggering a systemic crisis. in this context, systemically important financial institutions ( sifis ) are a special issue. sifis are banks which are so big or so interconnected that their failure might provoke a chain reaction which could eventually lead to a systemic crisis. thus, sifis have an incentive to engage in risk - prone behaviour and gamble on being bailed out whenever they get into trouble. consequently, regulation has to be designed to counter such moral hazard behaviour. an initial step could be to introduce some capital surcharge as well as more intensive supervision for sifis in order to enhance their stability. however, since failure still cannot be ruled out entirely, minimising moral hazard ultimately requires a system that allows an orderly restructuring of sifis. only then will it be possible to credibly bail - in investors and thus impose the necessary market discipline