philipp m hildebrand : policy implications of the financial crisis speech by mr philipp m hildebrand, vice - chairman of the governing board of the swiss national bank, at the conference, “ from fragility to stability ”, university of geneva, 18 november 2009. i would like to thank jurg blum and rita kobel for their valuable support in drafting this speech. i also want to thank nicole allenspach, philipp haene, and signe krogstrup for helpful comments and discussions. * * * introduction it is an honour to speak at the university of geneva this evening. i want to thank rajna gibson for her kind invitation. a year ago, we were in the midst of a perfect financial storm. following the bankruptcy of lehman brothers in mid - september, the imminent collapse of the global financial system became a distinct possibility. since those dark days, the situation has manifestly improved. a bold and unprecedented global policy response has had its intended short - term effect. while important questions remain as to the sustainability of the global recovery, we are no longer staring into the abyss of financial and – potentially – economic chaos. the worst financial crisis for at least 70 years has not resulted in a new great depression. on the other side of the ledger, the tangible and intangible costs of this crisis are enormous. the potential costs of the support measures taken – capital injection, asset purchases, and guarantees of bank debt – in the g7 countries together with australia, the netherlands, spain and switzerland amount to about twenty per cent of gdp in these economies. 1 moreover, the consequences of the crisis in terms of job, output and wealth losses, unprecedented increases in public spending and declines in public revenues are enormous. in the end, the citizens of the individual countries involved will have to foot the bill, one way or another. arguably the most important intangible cost, however, is the fact that governments had to issue an explicit guarantee for systemically relevant institutions, in effect executing a partial government take over of the financial system. 2 going forward, the world of finance will not be the same anymore. it should therefore come as no surprise that at the national and international level intensive efforts are underway to increase the resilience of the financial system. in recent months, these international reform efforts have included the presentation of many reports and recommendations. the financial stability board ( fsb ) has published two comprehensive sets of recommendations to improve financial regulation. 3 both have been

##s in crisis episodes. we should require that firms more clearly delineate different functions within their internal structures and simplify those structures. this will help facilitate an orderly wind down in the event of a severe crisis. it will probably also enhance effective management and risk management in these firms. this is an important point. as the crisis has demonstrated, in a number of cases it can be argued that firms were not only too big, but also too complex to be managed effectively. furthermore, we need a financial market infrastructure which – to the extent that this is possible – minimises the destabilising effects of a failure on the rest of the financial sector. a key element that cannot be emphasised enough is the ongoing effort to centralise the clearing and settlement processes in the derivative market. this enhances transparency and reduces counterparty risk. opposition to infrastructure reform by those firms that have in the past benefited from complexity and lack of transparency must be firmly overcome. at the same time, we need to keep in mind that central counterparties themselves can become single points of failure, with potentially devastating consequences. central counterparties must therefore have sufficient financial resources to withstand the default of the largest participants. operators and regulators should carefully evaluate the adequacy of the risk management models and financial resources of central counterparties. only if central counterparties are financially sound can they play their critical role in preserving financial stability. finally, as an ultimate resort, we cannot ignore the need to consider measures that address the size of banks, indirectly or directly. 13 admittedly, there are some benefits from size. but the empirical evidence suggests that these benefits are rather limited. economies of scale, whereby larger amounts can be produced at lower average cost, already appear to have been exhausted in the case of relatively small banks. 14 obviously, banking systems made up of only small banks are not immune to crisis episodes. but let us not make the mistake of using another problem as an excuse to shy away from the severe moral hazard problem associated with the largest banks. it is also sometimes argued that interconnectedness matters more than size when it comes to systemic importance. it is evident that both size and interconnectedness matter. recent empirical evidence, however, indicates that systemic importance increases more than proportionately with size. 15 the debate about the plans to split up some very large european banks demonstrates the difficulty of measures aimed at size. at the same time, the debate illustrates that such measures are not impossible. the extent to which we