cannot be traded off in a binary sense. second, the public should not define financial stability as preventing all financial firms from failing. in other sectors of the economy firms fail without putting at risk the funds of the public or taxpayers ’ money. we will not truly have solved the too big or important to fail problem and thus the public money problem until we have tools at our disposal which enable us to resolve large institutions if they get into trouble. this will create the right incentives for risk management. and third, regulators must use their judgement to mount a robust challenge to stop dangerous business models and investment practices. this last point is vital. financial services is an industry where arbitraging rules and regulations is habitual, even addictive. money is made this way. we have no desire unduly to suppress enterprise and innovation, but doing the right thing and preserving financial stability means accepting the spirit of the rules. this is not a small change. let me give you one important example. the new basel agreement emphasises loss - bearing capital – capital that can bear losses outside insolvency. it must stay that way, and not be chipped away under the banner of arbitrage masquerading as innovation. i have been asked a number of times in the last week whether i think that the new basel agreement sets capital requirements high enough. my answer is that if the capital buffers are in future genuinely loss bearing capital with no tricky wrinkles, and we keep to this outcome, we have taken a good step forward. sadly, that was not the case with basel 1 in the late 1980s when i started out as a banking supervisor. the consultation document on regulatory reform in the uk published by the government at the end of july emphasised the need for a judgement - focused approach by regulators “ so that business models can be challenged, risks identified and actions taken to preserve stability ”. what does this mean? a primary focus of the new prudential regulation authority will be on determining whether the business models, governance and systems and controls of firms will enable them to satisfy the public interest in financial stability in future states of the world. that requires both a macro and micro prudential view, and for the two to come together to reach forward - looking judgements on whether financial stability is likely to be preserved in a range of plausible future outcomes. this range of outcomes is important, and it also underlines the need to build up the role of stress testing. such testing is

basis that the stability of the financial system can be tomorrow ’ s objective, for the next person. but in order to achieve this, we need to be very clear on the benefits of financial stability. one of the questions i get asked most frequently is how we will ensure that the lessons of the crisis stick. we can only achieve this if the case for financial stability is well understood. there is a very clear parallel here with monetary policy. the success of monetary policy is founded on public acceptance of the benefits of sustained low inflation. that did not come easily, as the experiences of the 1970s taught. but once that public acceptance and interest started to become embedded, the task of monetary policy became easier – not easy, but easier. in this important sense, no such policy making apparatus can be independent of the will and interest of the public. and nor is the task of ensuring public acceptance ever finished. monetary policy has demonstrated that a firmly established and lasting institutional framework for policy making is a necessity. but exactly what is the public interest in financial stability? this can be a harder question to answer than for monetary policy, because financial stability cannot be so readily summarised in a statistical series. there is a temptation to generalise that you certainly know it when it isn ’ t there. i think there are at least four things that the public should want as part of the overall stability of the financial system. first, that they can have confidence in the safety and soundness of the institutions that hold their money and savings and write policies to protect them against risks. second, that those institutions have the capacity to undertake the stable and sound provision of financial services to the economy, including of course lending. third, that the system does not do business and exist on the basis of an implicit commitment that the state will have to use public money, the public ’ s money, to bail out firms that get into trouble. and fourth, that the public can place trust in firms and markets based on their reputations and the transparency of their dealings. regulation is important and it can help to foster that trust, but it cannot substitute for the trust that the public needs to have, in firms and markets. the state is not there to support the industry, and regulators are not there to substitute for trust in and the reputation of firms and markets. some important principles follow from the identification of the public interest in financial stability. first, a competitive financial system can only exist if it is rooted in stability : competition and stability