jaime caruana : the implementation of basel ii - central banks and the challenge of development remarks by mr jaime caruana, governor of the bank of spain and chairman of the basel committee on banking supervision, at the " central banks and the challenge of development " conference organised by the bis, basel, 13 march 2006. * * * introduction and overview i am honoured to have the opportunity to share some brief remarks on the ongoing implementation of the basel ii capital framework. i realise that not all of our institutions are responsible for banking supervision, but, as central bankers, we all share a common goal of promoting financial stability. in that regard, i ’ m sure we can all agree that a stable banking system is critical to the long - term growth of an economy. businesses and consumers need to have access to credit on fair and reasonable terms through all stages of the business cycle so that they can build and grow. and this access to financial services must be widespread, including all income brackets of the population, because it is one of the key elements that can help to improve living standards. we need an efficient and resilient payments system to maintain the flow of funds through the economy at all times. we need financial markets that remain active, liquid, and trusted regardless of events in the economy. we also know that banking crises can threaten macroeconomic stability through their potential effects on confidence, savings, financial flows, monetary control and the budgetary impact of bank rescue packages. in sum, achieving an inclusive, efficient, sound and stable financial system is an important and complex task, and it has many dimensions. to me, basel ii represents a tremendous effort of more than six years to analyze and promote some of the main elements of a sound banking system : those related to risk management and capital. my talk will address two main issues. first, i will share some reflections on how i believe basel ii will contribute to the stability of the financial system. secondly, i will offer some thoughts on steps countries can take in preparation for adopting basel ii. basel ii and financial stability banking is fundamentally about trust. banks are charged with a special public trust to safeguard customers ’ wealth. we have all seen what happens when customers lose trust in the ability of individual banks or the banking system as a whole to protect their savings. this puts a special onus on banking supervisors to ensure that banks operate soundly. no bank can maintain public trust for long if it lacks sufficient capital, so supervisors impose capital requirements to safeguard the

century to consolidate public finances, their position was weak when the crisis struck. still, most countries eased fiscal policy in 2009 as part of concerted european efforts to offset the negative impact of the crisis on growth and employment. this caused further deterioration of public finances, and for several euro area member states it led to an outright sovereign debt crisis. one reason was that the banks ’ non - performing loans eventually became a problem for the public sector, thereby weighing down on government finances. in many countries, fiscal expansion during the boom immediately before the crisis has now made way for extensive consolidation. in other words, fiscal policy has amplified cyclical fluctuations instead of dampening them. therefore, the lesson to us all – from the erm crisis in the early 1990s and recent years ’ financial crisis and sovereign debt crisis – is that it is important to address macroeconomic imbalances in time to prevent systemic risk. the financial crisis and the sovereign debt crisis revealed a clear need to strengthen political cooperation between euro area member states. the most recent crisis has exposed at least two fundamental weaknesses in the eu ’ s economic cooperation. firstly, the pressure for budgetary discipline was not strong enough. secondly, the one - sided focus on fiscal policy was too narrow. a comprehensive view of the member states ’ economic situation is required. it is also evident that price stability alone is not sufficient to ensure financial stability. in recent years, the eu member states have adopted a series of new rules aimed at addressing these weaknesses, including the fiscal compact, which tightens the requirements for fiscal discipline. in addition, the eu member states have adopted rules for surveillance of macroeconomic imbalances, under which the european commission is to monitor whether a member state is building up excessive imbalances. there is now more focus on systemic risk, and a european systemic risk board, esrb, has been set up. in denmark, we have introduced the systemic risk council, whose members were appointed last thursday. although denmark has, in many ways, navigated the financial crisis better than many other countries, we have generally had to learn the same economic policy lessons as others. in denmark, too, fiscal policy in the pre - crisis years reinforced the boom rather than dampening it. among other things, this led to higher wage inflation and weaker competitiveness. as a result of the procyclical fiscal policy, the downturn was more severe than it would otherwise have been. but the underlying fiscal policy was sounder than in the member