sprouted too many new buds too quickly. the new rosebuds had many attractive blossoms but as soon as it started to rain, most of them had no support and broke off. against this background, what are the deficiencies of the financial system that have to be remedied? at the microeconomic level, a whole cocktail of different factors led to the financial crisis. these included a general lack of transparency, insufficient capital buffers, the development of a scarcely regulated shadow banking system, and moral hazard in various forms – owing to ill - designed remuneration schemes, for example, or insufficient risk and liquidity management at the level of individual institutions. at the macroeconomic level, in particular, the pivotal role of certain agents and their influence on financial markets – in other words, their systematic importance – was underestimated for too long. in order to prevent the rose bush from sprouting too many weak buds and blossoms again, reforms at both the micro and macro levels are needed to make the financial system more resilient to future shocks. as a first line of defence, the microprudential level of regulation needs to be strengthened. the measures that have been proposed include higher capital and liquidity requirements. these are intended to lower the probability of an institution ’ s insolvency by enabling it to cope better with losses. proposals for reform were published by the basel committee on banking supervision ( bcbs ) in december 2009. the discussion is well advanced. a final proposal was adopted last weekend, and the g20 meeting in november will yield a final decision. as a result, financial institutions will be requested to hold not only a higher quantity of capital in their books but also capital of increased quality : minimum core capital requirements will go up from 2 % to 4. 5 %, for tier 1 capital from the current 4 % to 6 %. this will be supplemented by an additional buffer of 2. 5 % built up of common equity. this is designed to enable banks to absorb losses during periods of economic and financial disruptions. furthermore, a stricter definition of core capital will be applied. yet, this first line of defence needs to be supplemented. in a market - based economy it is neither possible nor desirable to entirely prevent the failure of individual enterprises. thus, a second line of defence has to be drawn at the macroprudential level of regulation in order to contain the impact of individual bank failures on the financial system as a whole and to make the

identifying and funding innovations, thus helping to advance the state of technical knowledge and promoting technological progress. for these reasons – and leaving aside additional effects due to the labour force and investment in human capital – an efficient financial system is indispensable for growth and necessarily becomes more complex with each advancing stage of economic development. in a sense, even the crisis with its massive repercussions for the real economy and its enormous costs illustrates how important the financial system and its stability are for economic performance and welfare. consequently, financial stability has become a top priority on the global policy agenda. but stability is not an end in itself. historical record tells us that financial crises have always been an element of market economies. therefore, the objective should not be to avoid them entirely but rather to contain their consequences. put differently, the challenge for regulatory reforms is to strike the right balance between the stability of the financial system and its efficiency. and, given the experience of the past few years as well as the channels through which the financial system affects economic growth, the two objectives are, to a significant degree, complementary. this means that the trade - off between stability and efficiency should not be seen as a zero - sum game. well - designed regulatory reform should make the financial system more stable without cutting into sustainable growth. 3. the crisis, regulatory reform and future growth the strength and scale of the financial crisis were unforeseeable. there had been warnings about various exaggerations and undesirable developments. but perceptions of where these might lead fell well short of the reality when it actually materialised. prior to the crisis, the global economy had been growing at a rapid pace. this was due, not least, to the fact that emerging markets were becoming increasingly integrated. this set free a large labour potential, provided high - yielding investment opportunities, and led to significant growth in per capita income. another driving factor behind growth was less benign, however. in too many areas, capital was not always channelled into the most productive areas. consider the housing market in some advanced economies as a point in case. an environment in which interest rates were exceptionally low as well as loopholes and weaknesses in the regulatory framework acted as catalysts for these undesirable and, ultimately, unsustainable developments. eventually, the underlying imbalances erupted and suddenly came to the surface – with the well - known costs. the situation in which the global economy found itself was comparable to a rose bush that had