regulation of banks. however, a balance needs to be struck. the jurisdictions where these problems are likely to be serious are few, and we do not want efforts to contain shadow banking activity unnecessarily to stifle genuinely productive intermediation and innovation. the fsb, international organization of securities commissions ( iosco ) and the bcbs have worked on addressing risks in several areas, such as money market funds, securitisation, banks ’ links with shadow banks and securities financing transactions ( sfts ). broad policy frameworks have largely been finalised in these areas, with work ongoing in relation to sfts ( such as an assessment of the impact of proposed recommendations ). it has been important to retain a degree of flexibility in the policy recommendations, given that some shadow banking markets are relatively small and not likely to be a major source of systemic risk. too big to fail on the fourth area, addressing the problem of “ too big to fail ” entities, a key area of work this year is to put forward a proposal for “ gone - concern loss - absorbing capacity ”, or “ glac ”, for global systemically important banks ( g - sibs ). the idea is that, even though additional capital surcharges above the ( now higher ) standard basel iii minima make it less likely that a g - sib could fail, they do not make it impossible. such entities are sufficiently large and interconnected that an uncontrolled failure could easily cause systemic disruption. therefore, it is argued that further loss - absorbing capacity is needed, to be called on at the point of non - viability, so as to allow vital functions to continue and non - critical operations to be wound down in a controlled way. this limits adverse spillovers to the system and the economy. generally, this loss - absorbing capacity is to come from a “ bail - in ” of certain classes of private creditors, so as to avoid calling on the public purse for a “ bail - out ”. bis central bankers ’ speeches this is an appealing idea, though it comes with the caveat that, to my knowledge, it has not successfully been done for a major institution to date. 3 there are several important issues to resolve in the process of crafting a proposal. among them are the questions of what instruments count towards any glac, how much glac may be appropriate, and what measures can be taken to mitigate risks of contagion

, that exposures to emerging economies could present substantial risk. given these events, the u. s. banking system has remained strong, possibly in large part because the recession in this country seems to have been relatively mild and short - lived. more directly, the strength seems also to reflect improvements in risk management at many banks and a greater awareness throughout the industry that institutions should promptly address problems as they emerge. this time both the banking industry and the regulatory agencies appear to have done just that - - acted promptly - and without going too far and unnecessarily constraining credit. much of the weakness among banks recently has been concentrated in large regional and money center banks, rather than in smaller institutions. bank earnings reached a record level in the first quarter of 2002, with one of the highest quarterly return - on - assets ratio ever reported of 1. 33 percent. net interest income was the driver of stronger revenue, despite lower commercial loan volume. loan loss provisions were significantly above the first quarter of 2001, although below levels of the fourth quarter. higher charge - offs were concentrated in commercial loans at large banks and in credit card specialty lenders. what areas may present heightened risks to community banks today? first, for most of the past decade, community banks - - particularly those in the asset range of $ 100 million to $ 1 billion - - have actively expanded their commercial real estate lending. since the early 1990s, larger community banks have expanded their commercial real estate portfolios from 13 percent of aggregate assets to 22 percent. to date, these credits have generally performed well, and my comments are not intended to suggest a material concern. these credits, however, account for most of the group ’ s increase in nonperforming assets over the past year. given the checkered history of commercial real estate lending and its increased relevance to many community banks, this portfolio must be monitored and managed carefully. we have often seen the cyclical nature of commercial real estate and its links to the general level of economic activity. the loss of anchor firms such as k - mart, for example, may reduce the market value of certain shopping centers and the consumer traffic and the financial strength of nearby businesses as well. the second area of potential risk relates to interest rates. for the industry overall, the federal reserve ’ s rate cuts last year may have proved to be a mixed blessing. lower interest rates undoubtedly eased payment pressures on many borrowers and prevented further deterioration in the quality of bank loan portfolios. liability