mr meister reviews the subject of bank insolvencies and moral hazard statement by mr. edgar meister, a member of the directorate of the deutsche bundesbank, at a symposium hosted by the university of frankfurt on 1 / 2 / 99. one of the pillars of our market economy is the fact that entrepreneurs are personally responsible for their business activities. generally, this principle also applies to banks. however, banks, as financial intermediaries and providers of financial services, play a special role in an economy. a crisis of one major bank, let alone the whole banking system, would have a serious impact on economic activity, and this also goes for the real sector. but then again, the special role of banks must not be interpreted to mean that bank boards can count on government support in emergencies. if they could, the risk of a precarious situation in the banking sector would increase even more. this would create a “ moral hazard ”, which would result in banks taking excessive risks in order to obtain higher returns, in the confidence that they could rely on government support in the event of a failure. banking supervisors must try to prevent both scenarios — serious external effects of bank insolvencies, for one thing, and moral hazard, for another — from happening. the crisis in south - east asia has shown that government guarantees and expectations of international assistance — which were met in the end — can lead to serious misalignments in a crisis situation ( to quote tietmeyer : “ do not display too much money in the shop windows ” ). avoiding crises must be the prime concern. efficient banking supervision can make an essential contribution to this objective. supervisors should be guided by the principle : “ as much entrepreneurial leeway as possible, yet as much state supervision as required ”. there have been some recent proposals to confer more supervisory tasks to the private sector ( g30 ). in principle, increased mutual monitoring among the banks, and hence a strengthening of market discipline, is a welcome idea. nevertheless, conceptual and practical problems should not be overlooked. for instance, more self - regulation by the market participants implies a transfer of legislative powers, but it does not mean that responsibility for resolving systemic crises would also shift to the private sector. state supervision will remain necessary as long as systemic risks exist which cannot be limited sufficiently through preventive measures or eliminated within the context of market control. besides, the self - regulation model, inter alia, assumes that the financial sector

intervention, especially since these activities do not necessarily have zero economic value - added. contrary to the basel ii approach, the penalty imposed on risky activities would become infinite. thus, given the inherent trade - off between the efficiency costs of intervention and its benefits, a reformed basel ii framework might provide a more balanced solution. this is also the case with regard to the introduction of an additional tax for the banking sector. even though such a tax could be useful in recouping some of the costs of the crisis, it is an inferior instrument in terms of internalising the effects of risky activities on financial stability. hence, the reform of the basel ii framework is rightly given preference by regulators and should be implemented with priority by policymakers. regardless of its actual design, the general objective of regulation on the microprudential level is to have a first line of defence by reducing the likelihood of individual bank failures. however, given our globalised and interconnected world and the interdependence of financial institutions and markets, even the failure of a single institution might lead to systemic disruptions. thus, it is necessary to complement a strengthened microprudential regulation with a macroprudential stance which as a second line of defence takes into account the stability of the financial system as a whole. one major aspect of macroprudential regulation would be the treatment of systemically important financial institutions. although the revised basel ii framework is part of a solution to this problem, broader reforms are necessary. these might include capital surcharges for systemically important institutions, better resolution regimes as well as a stronger market infrastructure. regarding the reform process itself, we have to bear in mind that the decisions we are about to make will shape the global financial system for years to come. thus, accuracy is more important than speed, and we have to be careful not to implement oversimplistic solutions. regarding the required complexity of regulatory measures, potential interactions have to be taken into account, as otherwise the danger of unintended consequences will grow. at the same time, the cumulative effect of new measures has to be considered, which makes thorough impact assessments of the intended consequences necessary. we are, of course, aware of the fact that a slow pace of reform increases regulatory uncertainty for market participants. but up to now, policy development has proceeded according to agreed and very ambitious timelines, reducing the uncertainty as far as possible. 3. international cooperation and harmonisation another factor that increases the complexity of the