erdem basci : financial and macroeconomic stability speech by mr erdem basci, governor of the central bank of the republic of turkey, at a conference on “ financial and macroeconomic stability ”, organised by the central bank of the republic of turkey jointly with the central bank of brazil, the bank of finland and the journal of financial stability, istanbul, 4 june 2012. * * * distinguished guests, welcome to the conference on financial and macroeconomic stability, organized by the central bank of the republic of turkey jointly with the central bank of brazil, the bank of finland and journal of financial stability. in november last year, we organized yet another conference on financial stability and inflation targeting, with a focus on financial stability. country experiences since then have shown once more how costly it would be economically and socially if and when financial stability is neglected. therefore, financial stability is of utmost importance for policymakers in attaining macroeconomic stability. as a matter of fact, this conviction, which is also supported by international platforms such as g20, imf and bis, has not only raised several new questions regarding the design and implementation of monetary policy, but also proposed a new research agenda in the academic literature. esteemed participants, sustainable growth, low inflation, steady employment growth, low levels of unemployment and a balanced public finance can be listed as the main indicators of macroeconomic stability. although economists were aware of the significance of the above listed for social welfare, financial stability had been in the back burner before the global financial crisis of 2008 – 2009. with the onset of the crisis, the importance of financial sector came to the forefront and it was understood that the costs will be immense if the instability in the financial sector spreads to the real sector. therefore, in the period ahead, maintaining macroeconomic stability and financial stability concurrently remains a major challenge for policymakers. new policy tools and new policies might be needed to achieve both stability targets. in this context, i believe that the conference on “ financial and macroeconomic stability ” will provide a significant contribution to policymakers. distinguished guests, excessive volatility in macroeconomic aggregates, namely production, employment, budget, foreign trade and inflation, might impair the distribution of income and assets, and reduce the welfare of that society. it is therefore of utmost importance to achieve macroeconomic stability and to sustain the welfare of the society. financial stability is crucial in providing an effective mechanism for the transfer of the economy ’ s resources from savers to producers

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