the nakedness of the banks. they didn ’ t solve the underlying problem – banks needed not loans but injections of shareholders ’ capital in order to be able to absorb losses from the risky investments they had made. from the beginning of 2008, we at the bank of england began to argue that uk banks needed extra capital – a lot of extra capital, possibly £100 billion or more. it wasn ’ t a popular message. but nine months later, market pressure forced banks to raise new capital or accept bis central bankers ’ speeches it from the state. uk tax payers ended up owning large portions of two of our four biggest banks, royal bank of scotland and lloyds tsb, but almost all banks would have failed had not taxpayer support been extended. that bold action in october 2008 could have happened sooner. but the most important thing is that it was done. and the policy of recapitalising the banks was soon copied by other countries. bailing out the banks came too late though to prevent the financial crisis from spilling over into the world economy. the realisation of the true state of the banking system led to a collapse of confidence around the world and a deep global recession. over 25 million jobs disappeared worldwide. and unemployment in britain rose by over a million. to many of you this will seem deeply unfair, and it is. i can understand why so many people are angry. it ’ s vital that we learn from the crisis. a good place to start is to ask, as the queen famously did, “ why did no - one see this coming? ” the answer is extremely simple : no - one believed it could happen. recessions were supposed to follow booms and high inflation, not periods of steady and sustainable growth with low inflation. there seemed to be no reason to expect the worst recession since the 1930s. after the ravages of inflation in the 1970s – younger listeners might need to be reminded that inflation hit 27 % in 1975 – it was i think understandable that we focussed on the need to bring inflation down. but conquering inflation was not enough to ensure stability. although inflation was under control, fragilities were building in the banking system. on all sides there was a failure of imagination to appreciate the scale of the fragilities and their potential consequences. no - one could quite bring themselves to believe that in our modern financial system the biggest banks in the world could fall over. but they did. that isn ’ t to say we were blind

stability of those institutions. they essentially ignored the tier 1 and total risk - based capital ratios in regulatory requirements. in the fall of 2008, there was widespread doubt in markets that the common equity of some of our largest institutions was sufficient to withstand the losses that those firms appeared to be facing. this doubt made investors and counterparties increasingly reluctant to deal with those firms, contributing to the severe liquidity strains that characterized financial markets at the time. finally, the crisis validated the concerns expressed by some academics and by policy staff at the bank for international settlements that the effectiveness of capital regulation was limited by its exclusively microprudential focus. capital requirements had been set with reference solely to the balance sheet of a specific firm. the risk weights assigned to the firm ’ s assets were calculated with reference to ordinary times, whether through a supervisory determination or a combination of supervisory formulas and a firm ’ s own modeling. this microprudential focus did not take into account the potential impact of a shock to the value of widely - held assets – whether exogenous, caused by the distress sales of such assets by a large firm suffering particularly severe problems, or, as in the financial crisis, a lethal interaction between these two factors. the limits of the microprudential approach were particularly evident with respect to very large, interconnected firms. there would be very substantial negative externalities associated with the disorderly failure of any such firm, distinct from the costs incurred by the firm and its stakeholders. the failure of one large firm, especially in a period of stress, significantly increases the chances that other financial firms will fail, for two reasons. first, direct counterparty impacts can lead to a classic domino effect. second, because losses in a tail event are much more likely to be correlated for firms deeply engaged in trading, structured products, and other capital market instruments, all such firms are vulnerable to accelerating losses as troubled firms sell their assets into a declining market. reform of capital regulation in the post - crisis period it is obvious that the post - crisis regulatory system will not be as dependent on capital requirements as the pre - crisis regime. dodd - frank itself is testimony to this fact, as are a number of changes already made by the bank regulatory agencies. there is now increased emphasis on market discipline, liquidity regulation, activities restrictions, and more effective supervision, in addition to capital requirements. reforms for money market funds and the triparty repo market, as well as more general attention to wholesale funding models