‘ capital ’ is the portion of a bank ’ s funding that can absorb losses ahead of creditors, allowing the bank to continue operating as a going concern or reduce losses to creditors and depositors in the event of failure. a key word in this principle is readily. to be useful in supporting a distressed bank, capital instruments must be able to absorb losses as and when they arise. capital instruments can be ranked based on their subordination, permanence and loss absorbency, with common equity tier 1 ( cet1 ) capital being the highest quality capital instrument. the reserve bank will consider the roles of the different tiers of capital and whether more emphasis should be placed on simpler and higher quality forms of capital. we are particularly interested in reviewing the role of convertible capital instruments and will give this some priority in the review. 5 / 9 bis central bankers'speeches the principle of loss absorbency is also relevant for our assessment of buffers that are required in addition to minimum capital ratios. the current regime includes a conservation buffer of 2. 5 % and the potential for a counter - cyclical capital buffer under our macro - prudential framework. such buffers enhance the ability of banks to readily absorb losses while remaining compliant with minimum ratios. an appropriate structure for capital buffers will be an important issue for the review. 2. capital requirements should be set in relation to the risk of bank exposures regulatory capital requirements must reflect the underlying risk of exposures in order to avoid distorting banks ’ risk - return decisions. critics of the basel framework maintain that ever - increasing risk granularity has led to a spurious sense of sophistication and that the pendulum should swing back to simpler, more objective measures of risk. 14 in particular, the use of internal models to determine capital requirements has been shown in practice to lead to excessively wide estimates of risk for what is the same underlying exposure. 15 the basel committee has agreed that a simplification of the framework and a reduction in model - based variation in capital requirements is desirable. however, as noted, we are yet to see the final shape of these reforms. we believe that model - based variations in risk measurement are less pronounced in new zealand, due in part to our restrictions on internal model parameters and our relatively simple approach to market risk measurement. however, we agree that excessive complexity is undesirable and that risk differentiation should only occur when it is based on objective and credible measurement. in the review, we

to the excessive risk - taking of the pre - crisis era. i don ’ t think the banking sector could ever be back to the double - digit returns of the past 20 years. it may rather converge to a “ new normal ” with more low - consuming - capital activities. in any case, a sustained profitability must require cutting operational costs, as well as a lot of investment in new technologies. new technologies are probably the most important new frontier for banks, and i will dwell on them in a minute. let me first widen the topic of this roundtable a little bit, to the financial system at large. banks aren ’ t the only financial players, nor should they be, in perspective, the largely dominant ones, at least in countries like italy. in this country the financial structure is already evolving, though at a still moderate pace. non1 / 2 bis central bankers'speeches financial firms, especially the biggest ones, are now using equity and bond markets much more than in the past for their financial needs, although still not enough, in my opinion. but in italy we may need not just more markets. non - bank intermediaries, such as private equity and venture capital funds, are still underrepresented in the financial landscape. however, from a prudential point of view there ’ s a delicate balance to strike between a more articulated financial structure, which is desirable per se, and the need not to give “ shadow banking ” unlimited freedom. we are working, together with our colleagues in the world regulatory circles, on such a difficult puzzle. let me conclude with some words on the third and most important new frontier that i ’ ve mentioned before for the financial system : technology. again i ’ ll look at this issue from a regulatory point of view. we are observing how digitalisation is already changing the financial business. although many of our intermediaries, particularly the smallest ones, are lagging behind in the process of digitalisation, the road ahead is clear : we are talking about technologies that are well consolidated, they are not “ new ” anymore. fintech firms are a step forward. in a stricter sense, fintech firms are new players aiming at crowding out traditional intermediaries like banks. banks are reacting in different ways : some are buying fintech start - ups and trying to internalize them in their business models, others are establishing partnership agreements and externalizing part of their production function, others are trying to internally develop fintech -