as a hedge today. but they are hedging a risk they helped create. all of this implies that business line diversification can be a double - edged sword. during the upswing, banks enjoyed windfall gains from bets at the race - track. this boosted their buffers. but when those bets turned sour, these same activities put at risk banks ’ day job – the provision of loan and deposit services to the real economy. 9500 sub - prime mortgage products at the height of the boom might well have been too many. but zero is surely too few. there is a second important downside to diversification. while it might be sensible for an individual firm to diversify its business lines to reduce its risk, if this same strategy is followed by all banks the end - result may be greater fragility across the whole system. why? because in their desire to look different than in the past, banks ’ business strategies may end up looking identical in the present. the financial system could then become more prone to herdlike upswings and lemming - like downswings. there is more than a hint of this behaviour during the run - up to crisis. banking strategies became a whirligig. building societies transformed themselves into commercial banks. commercial banks tried their hand at investment banking. investment banks developed inhouse hedge funds through large proprietary trading desks. hedge funds competed with traditional investment funds. and to complete the circle, these investment funds imported the risk all of the others were shedding. in their desire to diversify, individual banks generated a lack of diversity, and thus resilience, for the financial system as a whole. so recent crisis experience highlights some of the costs of bundling banking services. given that, there is an intellectually defensible case for some unbundling of these services. this would reduce the risks of spill - over between privately and socially beneficial banking activities. and it would help prevent banks making individually rational but collectively calamitous strategic choices. there are plenty of examples from the non - financial world, from genetics to geology, of diversity improving the robustness of systems. the financial system may be no different. the resulting financial landscape would, however, look rather different. there would be greater specialisation and diversity. the shopping experience for a banking customer would be more farmers ’ market than supermarket. • governance – stakeholders versus shareholders in deciding appropriate corporate governance arrangements, economists have tended to focus on the relationship between shareholders

and with them confidence. trust is an altogether different animal. it is based on beliefs, not observable proofs. it is grounded in perceptions rather than evidence. it is as much a psychological state as a financial one. 10 a clean balance sheet might instil confidence, but it need not repair trust. because it is a moral judgement, repairing trust can be a slow and painstaking business. moral compasses take rather longer to self - correct than magnetic ones. this has implications for the path of recovery in the period ahead. historically, credit has tended to lag the recovery in output in the majority of recessions, especially financial recessions. during the previous three major recessions in the uk – in the 1970s, 1980s and 1990s – credit to business recovered slowly and in some cases only several years after the recovery in activity ( charts 8, 9 and 10 ). this is consistent with trust between financial institutions and their customers being slower to recover than confidence more generally. moreover, unlike the situation today, earlier recessions in the uk were not primarily the result of financial factors. international evidence suggests that financial recessions have tended on average to be both costlier and lengthier. 11 normal recessions have been associated with a recovery in output to its previous peak after around 3 ½ quarters. recovery to peak output following financial recessions has on average taken around 5 ½ quarters ( chart 11 ). like its predecessors, lack of confidence may have “ caused ” this time ’ s recession. but it is lack of trust – and hence credit – that may shape the recovery. based on past evidence, as the governor has noted recently, we might anticipate a protracted period of repair. repairing trust – the low road to reform so what might be needed, beyond time, to repair trust in the financial system? a raft of reforms to the financial system, nationally and internationally, is currently being assembled. these measures will aim to strengthen banks ’ financial resources, risk management practices and governance. they are about bringing regulatory rules into the 21st century. this is the high road to reform – for example, higher buffers of capital and liquidity and higher standards of risk management. if successful, these reforms will help cleanse bank balance sheets. it is an open question, however, whether these efforts will be sufficient to restore public trust in the financial system. one reason why regulation might not be the whole answer is that trust in financial regulation is itself one of the casualties of crisis.