nout wellink : managing complexity speech by dr nout wellink, president of the netherlands bank and chairman of the basel committee on banking supervision, at the nautadutilh seminar, bussum, 10 november 2009. * * * i have been informed that the topic for discussion will be the new balance between banks and supervisors in the financial system. this is an issue i ’ m happy to address. however, before doing so, let me first say a thing or two about complexity in the financial system. how should we treat complexity? let me start by stating the obvious. a solid financial sector is crucial to the functioning of our economy. its existence allows the efficient allocation of capital between different activities and across time, and promotes the efficient spreading of risk within society. today, it is hard to think of any form of economic activity that is not in some way dependent on its existence. therefore, the stakes are high in the current debate on financial sector regulation. after the events of the last two years, everyone agrees that change is needed. however, opinions differ about the kind of change we need. first, there are those that see the complexity of the financial system as the root of the problem, and therefore propose to constrain finance much in the way it was until the 1980's. some suggestions along this line are narrow limits on the activities of banks, splitting supposedly “ safe ” banks from banks engaging in capital market activities, or constraining specifications of financial products to those pre - approved by authorities. second, there are those who think that complexity itself is not the root of the problems, but rather circumstances allowed the complexity of the financial system to contribute to the crisis. they believe that the goal of regulatory changes should not be to decrease complexity per se. rather, they think complexity should be made more manageable. in this debate, i find myself squarely backing the second view. the reason for this is that i do not believe complexity in itself to be a bad thing. complex systems are designed, in many cases, to be more useful and efficient than simple ones. radios from the 1950s – of the kind i used when i was an amateur broadcaster – are much simpler than the ones we have today. yet today, thanks to innovation and rising complexity, radios have become cheaper and more reliable. and, on top it all, they offer a much wider range of functionality and are easier to use. cars are another example where complexity and technology has been used

to make them safer, rather than more hazardous. wonderfully named features as abs and esc are only possible because of innovation driving growing complexity in car - making. this is the kind of complexity that keeps drivers safe every day. the finance industry also offers us some wonderfully names symbols of complexity, such as rmbs and cds. unfortunately, unlike their counterparts in the car industry, these are not currently associated with safety and reliability. so it is clear that innovation and complexity may have improved the system ’ s ability to allocate capital efficiently in many cases, but certainly not in all. this implies we should go back to the drawing board to improve the resilience of the financial system. but it does not mean we should go back to the past. innovation cannot be undone and the idea that tomorrow ’ s problems can be solved by yesterday ’ s regulation strikes me as overly simple and even dangerous, as it could constrain the possibilities for financial system to allocate capital around the world and transfer risk efficiently. while we are at the drawing board, we also need to address the issue of containing systemic risk. the new financial system as a whole, as well as its individual institutions, will need to be more resilient to shocks. the present - day financial system is a complex system, characterized by a high level of interconnectedness. therefore, monitoring the financial system as a whole, and the linkages between its elements, has become all the more important. such “ macro - prudential ” supervision mechanisms help to spot sources of financial instability at an early stage. a positive development in this regard is the establishment of the european systemic risk board next year. but changes are also at hand to strengthen each financial institution individually. and some of these changes will have a profound effect on the balance between banks and supervisors. managing complexity this brings me back to our topic of discussion. the balance between banks and supervisors. what changes are necessary for individual banks and supervisors, in order to strengthen the resilience of the financial system and manage its complexity? let ’ s start by looking at changes for individual banks. some policy proposals have received ample attention in the debate. in order to make the financial system more resilient to shocks, each individual bank will need to hold a bigger capital buffer than before. this can be achieved through higher overall buffers, increases in capital charges for specific activities, or a combination of the two. furthermore, the quality of capital buffers needs