, interconnections between institutions create potential fragilities across the system, as we saw last september. fourth, the risks associated with large - scale proprietary trading are probably harder to control in limited liability companies. so we need instruments to prevent the size, leverage, fragility and risk of the financial system from becoming too great. the resulting “ macro - prudential ” toolkit will contain a number of instruments to reduce risk, both across the system and over time. it must not be put together in a hurry. and i share the concerns of many of you that we are a long way from identifying precise regulatory interventions that would improve the functioning of markets. as far as individual banks are concerned, we face some uncomfortable choices about the structure and regulation of our banking sector. if some banks are thought to be too big to fail, then, in the words of a distinguished american economist, they are too big. it is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure. something must give. either those guarantees to retail depositors should be limited to banks that make a narrower range of investments, or banks which pose greater risks to taxpayers and the economy in the event of failure should face higher capital requirements, or we must develop resolution powers such that large and complex financial institutions can be wound down in an orderly manner. or, perhaps, an element of all three. privately owned and managed institutions that are too big to fail sit oddly with a market economy. one important practical step would be to require any regulated bank itself to produce a plan for an orderly wind down of its activities. that would provide the information to the authorities the absence of which made past decisions about the future of institutions difficult. making a will should be as much a part of good housekeeping for banks as it is for the rest of us. and it would be sensible for the various authorities to work across national boundaries to identify detailed plans for how each large cross - border financial institution could be wound down. the bank of england has a new statutory responsibility for financial stability. bank rate is the instrument we deploy to achieve monetary stability, and should be used exclusively for that purpose. to achieve financial stability the powers of the bank are limited to those of voice and the new resolution powers. the bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between. like the

t preceded by an unsustainable boom in output. in the five years leading up to the crisis, overall gdp growth remained close to its long - run average and inflation differed from the 2 % target on average by only 0. 2 percentage points. diverting monetary policy from its goal of price stability risks making the economy less stable and the financial system no more so. to argue that monetary policy should be directed to counter inadequately priced risk is to argue that unemployment is a price worth paying to tame the banking system. inflation targeting is a necessary but not sufficient condition for stability in the economy as a whole. when a policy is necessary but not sufficient, the answer is not to abandon, but to augment, it. indeed, the overarching lesson from this crisis is that the authorities lacked sufficient policy instruments to take effective actions. nowhere was this more evident than in dealing with northern rock in the absence of proper resolution powers. for domestic institutions that particular issue was settled by the banking act 2009, and the new resolution powers were successfully deployed by the bank to deal with the dunfermline building society in march. what other powers are required? there is a broad consensus that our traditional policy instruments need to be augmented by a “ macro - prudential ” toolkit. but what are such “ macro - prudential ” instruments for? are they to increase the resilience of individual banks, or are they to protect the economy from the banks? the former implies a sensible extension of the current regime of capital requirements for individual institutions. the latter goes to the heart of the problems caused by the financial sector as a whole for the rest of the economy. we need to reflect more deeply on the nature of the failures before designing a regulatory response – after all many financial markets continued to function well. but banks entered the crisis with historically low levels of liquid assets, and inadequate levels of capital with which to absorb losses. moreover, in the united kingdom, the financial sector became too big and too highly leveraged. first, the size of our banking system was, as a proportion of gdp, five times that in the united states, and the risks to the uk taxpayer correspondingly greater. second, the process of reducing very high leverage is doing great damage to the rest of the economy. and the required adjustment still has a long way to run – few of the largest banks in the united kingdom managed to reduce their leverage ratios through 2008, which remain at historically high levels. third