would have you believe, there is some price worth paying to reduce such tail risks in the future. this past weekend ’ s historic basel iii agreement strikes exactly the right balance. in my remarks today, i will focus on the costs and benefits of financial sector reform. i will argue that the economic case is compelling and the basic stakes enormous. financial crises are normally followed by financial repression ; economic downturns, by increased protectionism. without credible, coordinated financial reforms, we risk losing the open trading and financial system that has underpinned the economic miracle of recent times. j. dimon, chairman and ceo, jp morgan chase & company, in testimony to the u. s. financial crisis inquiry commission, 13 january 2010. the role of the financial sector before analysing the impact of the reforms, allow me to discuss briefly the role of the financial sector and how it failed during the crisis. by translating savings into productive investment, finance is central to economic growth. it has three core functions. first, through the payments system, it facilitates decentralized exchange, which is fundamental to the functioning of a market economy. second, finance transforms the maturities of assets and liabilities, taking short - term liabilities, such as deposits, and transforming them into long - term assets, such as mortgages or corporate loans. households and businesses can therefore do the reverse, holding shortterm assets and longer - term liabilities. this helps them to plan for the future and to manage risks arising from uncertainties over their cash flows. the social value of maturity transformation is unquestioned, but its performance creates fundamental risks, which requires public intervention. 2 third, the financial system intermediates credit, channelling funds from savers to investors. this allows savers to diversify their risk and everyone to smooth consumption over time and across states of the world. young families can borrow to buy a house ; students can pay for university. people can invest for their retirements and businesses can finance working capital and investment. however, if risk is persistently mispriced, these savings and investments will be misallocated and economic welfare reduced. the crisis financial services are supplied by a combination of banks and markets. in recent years, markets grew to the point that they became important alternatives to banks for corporate and household finance. more and more of the traditional functions of banks – including maturity transformation and credit intermediation – were conducted through a broader range of intermediaries and investment

. in the 10 years following a financial crisis, the median output growth rate decreases by 1 per cent, and the unemployment rate increases by 5 percentage points. 9 experience suggests that costs build well into the future. in studies released last month, the basel committee found that the median cumulative loss of past financial crises was 63 per cent of national gdp. given the scale of potential losses, there are clearly large benefits to reducing the frequency of crises ( chart 2 ). the extensive analysis of the basel committee suggests that higher capital and liquidity standards would do just that. in particular, the combination of strengthened liquidity standards and a 2 - percentage - point increase in bank capital ratios would raise the annual expected level of gdp by 1. 8 per cent relative to trend. see c. reinhart and v. reinhart, “ after the fall ”, forthcoming in macroeconomic policy : post - crisis and risks ahead, federal reserve bank of kansas city economic policy symposium, jackson hole, wyoming, 26 – 28 august 2010. because this improved performance accrues over time, it is a gift that keeps on giving. using a conservative real discount rate of 5 per cent, the cumulative present value of this better performance is equivalent to more than 35 per cent of gdp, or €0. 9 trillion for germany. 10 some in canada argue that our sound financial system implies that the potential gains are small for our country and the g - 20 reforms are, therefore, unimportant. this is misguided. in open economies such as ours and germany ’ s, reducing the incidence of foreign crises is even more important than domestic benefits. today ’ s reality is one of deep interconnectedness, where financial problems in other regions spill rapidly into our own. in an increasingly multipolar economy, we simply cannot afford to lurch from crisis to crisis every five years. to reduce this frequency, we need a strong, universally applied framework. the basel iii rules, combined with the fsb and imf ’ s review processes, have the potential to be just that. costs of reform despite the clear benefits, stronger prudential standards also impose costs. banks can follow several strategies to meet regulatory demands for higher capital requirements. most obviously, they could raise additional capital in public markets. if given sufficient time, they could generate capital internally through retained earnings. in addition, they could pass on some of the costs of the higher standards to their customers through higher interest spreads or increased fee income. finally,