managing financial risk ”. the message was clear : the technological frontier of risk management had been shifted outwards decisively. a cursory search suggests that there have been more than 200 books published on var since the october 1987 crash, or roughly one a month. the date of birth of stress - testing is harder to trace. early mention is made of it in a technical note by riskmetrics in 1996. but it is clear that stress - testing was given considerable impetus by the failure of ltcm more than a decade after the october 1987 crash. unlike var, which had private sector origins, the official sector appears to have been at least as much a driver behind the adoption of stress - testing. by 2001, under the auspices of its financial sector assessment programme ( fsap ), the imf was publishing details of its stress - testing methodology and experience. today, the same cursory search reveals over 250 articles on stress - testing in the past ten years, or more than one a fortnight. we were experiencing a second wave of technological revolution in risk management. this technological transformation contributed to what was, with hindsight, an extraordinary period of growth and success for the financial system and financial markets – a golden decade. between october 1998 and june 2007, banks ’ share prices increased almost 60 % and their balance sheets rose more than threefold. in some markets growth was little short of explosive, with the rise in volumes outstanding in the cds market making moore ’ s law look positively sluggish. and why was this credit boom not destined to end in bust? because this time was different. at the same time as returns were being boosted by bigger balance sheets and financed by higher leverage, risk was being held in check by a shift in the technological frontier of risk management. a new era had dawned, one with simultaneously higher return and lower risk. this miracle came care of a compelling combination of cavalier risk - takers and roundhead risk - managers. or so ran the rhetoric. with hindsight, this golden decade and its aftermath has all the hallmarks of, in charles kindleberger ’ s words, manias, panics and crashes. enthusiasm about return gave way to hubris and a collective blind eye was turned to the resulting risk. this was a latter - day version of the hans christian andersen fairy - tale, “ the emperor ’ s new clothes ”. in a classic collective delusion, the emperor ’ s new clothes, you will recall, were admired

too low. the main argument of late has been whether our recent proposals on capital buffers for the largest banks operating in uk markets have diverged from previous post - crisis commitments on the level of capital banks should maintain both in going concern, and the overall level of loss absorbency available amongst the liabilities of a bank to enable a resolution to occur if needed. to put it into context, the capital standard we have developed is based on the last quarter century of bank performance – including the financial crisis – such that the probability of bank failure during that period would have been extremely low. in aggregate terms we have not diverged, and if anything our recent proposals put the level a little higher than that suggested, for instance, by the independent commission on banking, but not by enough to make a big point of it. it is true that within that aggregate we have introduced a new element in the form of incentives to protect the stability of the financial system. we have followed through wherever possible on the principle that larger and more complex banks should have higher capital buffers because they pose a greater risk to the stability of the financial system. consistent with that principle, we have created a tiered system of increasing capital requirements but left the topmost tier unpopulated. this empty tier is not a product of a craven fear of putting a bank there, but rather to create a disincentive to further complexity. so, we don ’ t see this element of the design as contradicting its goal. we could argue about the merits of small changes in the capital standard, but that is not in my view a worthwhile exercise. what is more notable is the divide between this view of strengthening banks ’ loss absorbency and the alternative view that the answer lies in a radical restructuring of the banking system to require banks to have loss absorbency which would be a substantial part ( say 20 % to 30 % ) of their total balance sheet 2. it is wrong in my view to conflate an argument about small differences in capital buffers with one that is all about a different financial system. i want to spend a few minutes on this alternative view, on what it would mean, and why it is advocated. to be clear, i am not commenting as a supporter, but rather to try to cast light on this big issue. the essence of the argument as i see it is that it is asserted by supporters of, let ’ s call it the “ big equity ” school, that we cannot