, capital for trading book exposures was distressingly inadequate. in response, the committee finalised last year a series of enhancements to the trading book rules. these higher capital requirements capture the credit risk of complex trading and derivative activities and require banks to calculate a stressed value - at - risk. the crisis also exposed weaknesses in banks ’ risk management and measurement of securitisation and off - balance - sheet exposures. this shortcoming resulted in large, unexpected losses. the committee ’ s july 2009 enhancements included new rules to strengthen the treatment for certain securitisations in pillar 1 by introducing higher risk weights for resecuritisation exposures. counterparty credit risk is another key risk for which the regulatory capital improvement is needed. the december enhancements proposed by the committee are meant to strengthen the resilience of individual banking institutions and reduce the risk that shocks are transmitted from one institution to the next through the derivatives and financing channel. raising the quality of the capital base the committee ’ s efforts to improve risk coverage are a crucial element of the capital adequacy equation but this is only half the story. the other half relates to the quality of the capital base backing banks ’ risk exposures. the committee has proposed a series of measures that would overhaul the definition of capital. this is the second objective of our reform programme and it is set out broadly along two lines. first, the level and the share of the highest quality capital in tier 1, namely, common equity and retained earnings, will rise substantially. during the crisis, losses came directly out of retained earnings but because of other forms of financial instruments in the capital base, some banks maintained deceptively high tier 1 capital ratios. moreover, in the case of many banks, non - common tier 1 capital instruments ultimately had to be converted into common equity before confidence was restored. second, and just as important, our proposal introduces a rigorous set of deductions and exclusions from common equity to arrive at a more transparent, meaningful definition of capital and to restore the credibility of the tier 1 capital base. leverage ratio as a backstop to the risk based requirement a third objective is the introduction of a leverage ratio to backstop the risk - based system. at the micro, firm - specific level, many firms were too aggressive in gaming the system. the risks that built up in the trading book with inadequate regulatory or economic capital were a case in point. many firms engaged in hedging strategies where the risk

nout wellink : the role of financial imbalances in the setting of monetary policy – lessons from the current crisis introductory speech by dr nout wellink, president of the netherlands bank and chairman of the basel committee on banking supervision, at the workshop on “ the role of financial imbalances in the setting of monetary policy. lessons from the current crisis ”, amsterdam, 23 june 2008. * * * the recent financial turmoil has highlighted once again that the role of financial imbalances is a major challenge for central banks focusing on price stability. most of the analyses of the causes of the financial turbulence that i have read stress the role of new financial developments, which make this event special. but the recent crisis is just one of a series of episodes over the past 30 years when the paths of asset prices – most notably equities and housing – were a highly distorting factor that ex post turned out to have disruptive macroeconomic effects. the aim of this workshop is to further our understanding of the role of monetary policy in addressing financial imbalances. the speakers in the panel that will follow my remarks will discuss whether monetary policy should be actively used to prevent the build up of financial imbalances, and what the optimal monetary policy response should be when financial imbalances do occur. this debate hinges on the question of whether we can ex ante identify imbalances that are building up. in my remarks, i will address this issue based on my experience as policy maker. in my view, there are several, interrelated ingredients of an accumulating imbalance : the first is low real long - term interest rates relative to a natural rate of interest, particularly in a context of a robust economy characterised by high productivity growth, strong economic growth and low inflation. it is well known that the natural rate of interest is difficult to estimate – just think about the challenge of assessing changes in productivity growth. but i think that a comparison with a historical average of past actual rates can give an idea of whether interest rates are out of line. low interest rates underpin the second ingredient, which the recent financial turmoil has brought to everyone ’ s attention – strong credit growth. the current intellectual debate highlights how standard macroeconomic theories in the lucasian tradition – based on optimizing agents with rational expectations, complete markets and fully flexible prices – have a hard time assigning credit a relevant role. economists are therefore increasingly turning for insights to the theories of minsky or kindle