jean - pierre landau : extreme events in finance – some reflexions remarks by mr jean - pierre landau, deputy governor of the bank of france, at the conference on extreme events jointly organised by the bank of france and the toulouse school of economics ( tse ), paris, 3 september 2008. updated on 23 november 2008. i want to thank benoit coeure and my colleagues laurent clerc, sylvie matherat, imene rahmouni, anne - marie rieu and pierre - francois weber for their comments and suggestions on earlier versions. * * * the current crisis is a strong reminder, if needed, that extreme events can occur inside the financial system. over the last year, we have witnessed many episodes ( 1 ) whose outcome can reasonably be defined as " catastrophic " and, ( 2 ) which could not have been predicted according to probability based on past experience. here, i would like to develop four points : are financial systems prone to extreme events? is this propensity aggravated by modern finance, as it evolved during the last decade? does this problematic help us understand the current crisis? and, finally, what are the possible policy responses? are financial systems prone to extreme events? i can see at least two reasons why this may be the case. 1. financial systems are complex systems. they are based on interdependence between multiple actors and counterparties. transmissions occur through networks whose structure and architecture is constantly transformed by financial innovation and regulatory arbitrage. this potentially creates numerous feedback loops. it is well known that such systems can exhibit the following features : non linearity and discontinuities ( a good example being liquidity freezes ) ; path dependency ; sensitivity to initial conditions. all this accounts for truly unpredictable behaviour. it creates uncertainty in the knigthian sense : even with full knowledge of the " fundamentals " it may be impossible to associate a probability distribution to future states of nature. however, complexity creates the possibility of extreme events. it does not make them happen necessarily. other factors may also contribute : one of them is human behaviour. 2. financial systems are " human " systems. their dynamic is shaped by the way human beings react to changes in their environment. those reactions can help and amplify initial shocks to a point that a real " catastrophe " may occur. herd behaviour has long been known as an essential feature of financial markets. more subtly, individual reactions, by themselves rational, can, by the virtue of

v leeladhar : basel ii and credit risk management inaugural address by mr v leeladhar, deputy governor of the reserve bank of india, at the programme on basel ii and credit risk management, organised by the centre for advanced financial learning for the whole - time directors of the commercial banks, goa, 15 september 2007. * * * mr. gordy, mr. bhattacharya, distinguished participants, ladies and gentlemen, i am delighted to be with you this morning at the inaugural of the third programme in the series being organised under the aegis of the centre for advanced financial leaning ( cafl ) on the theme of basel ii and credit risk management. i am indeed thankful to the organisers for providing me this valuable opportunity to share my thoughts on this very topical subject with this august audience – which, needless to say, has a pivotal role to play in implementing the basel ii framework in the indian banking system. in fact, this programme itself, which has been tailor made for the whole - time directors of the indian banks, signifies the importance the rbi attaches to sensitising the top management of the banks to the conceptual constructs underpinning the new framework. 2. i am inclined to believe that the basel ii framework is no longer a novelty for most of you. while the technical aspects of credit risk management in the basel ii environment will be covered during the course of this two - day seminar, i would like to present a brief bird ’ s eye view of the evolution of the capital adequacy norm for the banks over the decades so as to put the new framework in perspective, the imperatives that led to its refinement in the form of basel ii, the expectations of the rbi from the banking system during the implementation phase and beyond, and the issues and challenges facing us that will need to be addressed in implementing the new framework in a non - disruptive manner. the evolution of capital standards 3. it is interesting to note that till the 1980s, the risk - weighted approach to capital adequacy was not in vogue but the bank ’ s capital was measured through the traditional gearing ratios. during the 1980s, the increasing competition amongst the international banks and rapid growth in their assets had led to concerns about their deteriorating capital levels. this concern was aggravated by the debt crisis in some of the emerging markets. while the national authorities and regulators in many countries began exhorting their banks to improve their capital ratios, it was realised that