risks that a bank poses to its stakeholders and the financial system. this will enable them to deal with risks at an early stage. but if the rulebook becomes too extensive and too detailed, supervision turns into a simple boxticking exercise. a large, detailed and seemingly comprehensive set of rules would make supervisors less flexible and effective ; it would leave no room for discretion. supervisors would no longer be able to react quickly to newly emerging risks in an ever - changing banking sector. they would be walled in by rules that were devised to cover every possible situation but, in reality, were outdated right from the start. so, looking ahead, we must fight the urge to make the rulebook ever more detailed. but don ’ t get me wrong – we shouldn ’ t unwind any of the reforms. what has been done was necessary. but we should be cautious about going too far. a few clear principles can be more effective than 1, 000 complex rules. the two pillars of regulation and supervision are equally important and we should not favour one at the other ’ s expense. and this brings us to the third pillar of a stable banking sector : market discipline. with all this talk about rules and supervision, we must not forget that banks operate in a market economy. so why not use market forces to keep risks in check? there is nothing like the prospect of failure and financial loss to keep a lid on risk - taking. and this, as a general rule, is the essence of market discipline. investors who stand to lose their own money will be more cautious than investors who can offload losses onto someone else. but, as i said earlier, markets have not always exerted discipline. during the crisis, bank failures were rare. but why? well, first, there was a lack of tools to resolve failing banks – particularly across borders. and second, there were fears of contagion and a meltdown of the entire financial system. so, in the end, governments often stepped in and propped up failing banks with public funds. there was no chance for the market to impose discipline. this has changed. in europe, we now have a single resolution mechanism for banks. it was designed to ensure that banks can fail in an orderly manner without damaging the financial system. this new mechanism has recently passed its first series of tests. generally speaking, it was successful, although some adjustments are still needed. 3 / 4 bis central bankers'speeches in any case, we have taken a big step towards

must be careful not to disturb this balance. and here is where i see some cause for concern. regulators might be tempted to lay down rules to cover every eventuality – think of the example i just gave you. and their motivation would certainly be laudable. but their goal would be unattainable. it is just not possible to cater for every potential situation. there are too many possibilities, most of which we cannot anticipate. no one knows what financial innovations might emerge ; no one knows where technological change will lead us ; and no one knows how the economy will evolve over the coming decades. if we try to cover everything, the rulebook will, at some point, become too detailed, too big and too complex. from that point onwards it will stop making the banking sector a safer place and instead create new problems. first, overly complex rules facilitate regulatory arbitrage. yes, we could add page after page to the rulebook, setting out detailed rules, definitions and thresholds governing how banks should deal with risks and specifying, for instance, which tools supervisors should use in certain situations, and when. but with each new page, more loopholes open up. it becomes easier for 2 / 4 bis central bankers'speeches banks to game the system. this defeats the purpose of a rulebook and poses a threat to stability. second, there is the problem of interaction. the more rules there are, the more they can interact and interfere with each other. if there are two rules, there is just one way in which they can interact. if there are 1, 000 rules, they can, in theory, interact in at least 500, 000 ways. it becomes ever more difficult to foresee the overall effect of the rules, and the danger of unintended sideeffects increases. and third, there is the issue of costs. the thicker the rulebook, the more expensive it becomes for banks to comply with it and for supervisors to do their jobs. these costs are justifiable if each additional rule reduces the risk of another crisis. however, at a certain point the costs of the rules begin to outweigh the benefits. so, instead of having overly detailed rules, we should have a strong basic set of rules that allows supervisors some discretion.. supervisors have the relevant skills and experience, and in - depth knowledge of the banks they supervise. we should ensure that supervisors can continue to apply their judgement. they should be empowered to assess the