in and year out. 2. supervision of individual firms one of the things that should not be neglected is that the severity of this crisis was as great as it was partly because a large handful of individual massive firms failed due to poor management and weak balance sheets. part of the solution lies, therefore, in much better microprudential supervision and regulation of individual firms. the basel committee has had core principles for effective banking supervision for some considerable time now. but, going beyond that, the fsb has encouraged and is sponsoring an exercise on effective supervision of sifis, significantly important financial institutions. a remarkable fact is that although the style of banking supervision varies enormously across the world, almost nothing seems to have been done to get to the bottom of the question of which approaches are the more effective – having an army of on - site examiners, such as for example in the united states ; or relying on offsite analysis, which tends to be the pattern in much of europe. an exercise led by julie dickson for the financial stability board is producing an evaluation of what is needed to supervise the largest firms in the world effectively. the idea is that that will either get encapsulated in an fsb code or in a re - draft of the basel core principles for effective supervision. 3. capital and liquidity the third element is capital and liquidity. virtually all crises have at their root over leverage in the financial sector and excessive maturity mismatch. we need to overhaul the corresponding policy instruments – capital and liquidity requirements. on liquidity, basel is introducing an accord for minimum liquidity requirements for the first time ; this is about a quarter of a century after it was first contemplated and so rather overdue, but therefore very welcome. there is an awful lot of debate around this still. many in the industry – in the banking industry – have been resisting it. but this will happen. it will lay down minimum standards for banks to hold some resiliently liquid assets and about the funding of illiquid assets. to date, much more prominent has been the work on capital. although there has been some dilution of the proposals from a few months ago, real substantive progress is being made in reforming the minimum standards and in introducing various buffers, taking into account credit cycle conditions and the circumstances of sifis. the key element of the overall package is that “ capital ” will mean capital. the world of hybrid instruments – pretending to be so - called capital instruments

but which in fact cannot truly absorb losses in a going concern – should become more or less a thing of the past. the bank of england would like it to be completely consigned to the past. only equity can absorb losses. for that reason, in calculating regulatory capital, deductions from capital should really be from equity. as part of the emerging compromise, there will be some derogations from that, but the derogations should be transparent. markets should learn to evaluate bank ’ s capital adequacy on the basis of what is made transparent about the makeup of that capital. the other really key change will come in stages – partly in the package this autumn and partly during next year and beyond – which is reducing the pernicious regulatory arbitrage that has existed between “ banking book ” capital requirements and “ trading book ” capital requirements. far too many instruments that were held in the trading book were subject to low capital requirements but actually could not be traded, leaving values exposed to big swings in liquidity premia. this was a fatal design flaw in the existing regime, and it is one which i hope should be fixed over the next year or so though the basel committee ’ s “ fundamental review of the trading book ”. 4. too big to fail at the centre of the reform effort in the fsb work is “ too big to fail. ” if one of the largest firms in the world got into trouble right now, in almost every country in the world we would not be able to cope with its demise other than through fiscal support. this is completely unacceptable. if there is one thing that i think unites the members of the g20 – at the political level and at the official level – it is that this will be consigned to the past. we will re - introduce market discipline back into the financial system, which really means re - introducing capitalism back into the heart of capitalism. the acid test has to be whether, for every financial institution in the world, it could be resolved if it faces distress in a way that does not disrupt the flow of essential financial services to the economy and without state solvency support. that is the single goal in this area. when achieved, it can transform the global financial system more than anything else. it ’ s not for me to set out the ideas today ( svein will do so later ), but there are ideas developing that i believe will, in at least some key centres, become concrete policies