and bank culture must all play effective roles. regulation establishes what is legally permissible for banks to do ; supervision helps to reinforce those rules and evaluate whether the bank ’ s controls and other processes are conducive to safety and soundness ; and bank culture sets the norms for what is appropriate behavior. 9 but, at the same time, these pillars are mutually reinforcing. regulation and supervision, for example, attempt to address various market failures in banking that can contribute to excessive risk taking. 10 bank culture, in turn, helps establish norms in areas where regulation may be silent. in this way, regulation, supervision, and bank culture are complements, and deficiencies in any of these pillars can be problematic. for example, as we have seen in cases of unsafe or unethical behavior in recent years, strong regulation and supervision cannot substitute for deficiencies in bank culture — especially not on a timely basis. it is the public sector ’ s job to establish and enforce rules, but rules are inherently limited in their ability to constrain conduct and behavior. much of our regulatory regime has been developed in response to financial problems that have arisen over time. because regulation is typically reactive in this way, it may not always keep pace with the evolution of the financial system or the broader economic environment. also, we must recognize that, at times, actions will be taken that are clearly inconsistent with the spirit of the rules that are place, or the rules will simply be violated. consider the use by lehman brothers of so - called repo 105 transactions to window - dress its balance sheet. beginning in late 2007, lehman used repo 105 transactions to temporarily remove securities from its balance sheet for a few days in order to mislead investors and counterparties about its financial condition. these transactions had the benefit of being 4 / 8 bis central bankers'speeches recognized as “ sales ” even though they were nearly identical to standard repo transactions that stayed on the balance sheet. in another example, following the introduction of basel iii, some banks tried to reduce their capital requirements by transferring risk to other counterparties. in certain cases, this occurred even when those counterparties did not provide any additional resources to absorb potential losses — either because they were very thinly capitalized, or were affiliated with the banks in question. i would also note that the establishment of too many bright - line rules may prove counterproductive to the goal of encouraging good bank cultures. for one thing, detailed rules can

william c dudley : the importance of incentives in ensuring a resilient and robust financial system remarks by mr william c dudley, president and chief executive officer of the federal reserve bank of new york, at the us chamber of commerce, washington dc, 26 march 2018. * * * it is a pleasure to have this opportunity to speak to you. in my remarks today, i will discuss financial regulation and the ways in which proper incentives help ensure resiliency in the financial system. as always, what i have to say reflects my own views and not necessarily those of the federal open market committee or the federal reserve system. 1 we have come a long way since the global financial crisis in building a more resilient financial system — one that can better support the provision of financial services to american households and businesses such as those represented here, both in good times and in bad. but, there is still unfinished business. on the regulatory side, for example, there is more work to be done to ensure that a systemically important bank can be resolved effectively on a cross - border basis in the event of failure. additionally, the efficiency, transparency, and simplicity of the regulatory system could be improved without weakening the core reforms to capital, liquidity, and resolution that have made the financial system much stronger. most importantly, we need to recognize that an effective regulatory regime and comprehensive supervision are not sufficient. we also need to focus on the incentives facing banks and their employees. after all, misaligned incentives contributed greatly to the financial crisis and continue to affect bank conduct and behavior. 2 today, i will address this issue of incentives, with emphasis on the complementary roles of regulation, supervision, and bank culture. each of these is necessary to ensure that we have a robust and resilient financial system not just today, but also in the future. progress since the financial crisis the financial crisis was a watershed event that exposed severe deficiencies in the financial system — including the inadequacy of bank capital and liquidity buffers, poor risk management and internal controls, and bad bank cultures. many financial firms took on an excessive amount of risk and did not always act in ways consistent with the interests of their customers or the broader public. the crisis revealed woeful shortcomings in many of these elements, with terrible consequences for the economy and millions of people. over the past decade, the official sector and the financial industry have made considerable progress in addressing these problems. the banking system is much sound