banks. and a failure of these could also lead to systemic distortions, as was demonstrated by the case of long - term capital management or – more recently – lehman brothers. moreover, european experience shows that universal banks with a broad range of business can also be a stabilising factor during a crisis. however, the most fundamental problem of the volcker rule lies in the fact that a complete prohibition of certain activities – activities that are perhaps more risky but not necessarily economically inefficient – is a very far - reaching market intervention. the reformed basel ii framework and the stabilisation fund also try to restrict possibly destabilising activities but, unlike the volcker rule, the penalty they impose on these activities is finite. technically speaking, the volcker rule enforces a corner solution and, as such, might have unintended and unfavourable consequences. it could, for example, have undesirable effects on the transmission of monetary policy. i have just described three different approaches to reducing the likelihood of failure for individual banks, particularly if they are systemic. these three approaches represent three different levels of intensity. while the basel ii framework puts a shadow price on certain risky activities, the stabilisation fund taxes them, and the volcker rule, as a corner solution, prohibits them entirely. however, as none of the three approaches would be able to entirely rule out the possibility bank failures, they would have to be reinforced by other measures. that is, a second line of defence would have to be drawn. 4. reducing the systemic impact of individual bank failures if a bank gets into trouble and if its problems threaten to spread throughout the financial system, supervisors have to act quickly. this requires a proper set of instruments and, ultimately, private or public money that can be mobilised at short notice. for this reason, proposals such as the stabilisation fund include the establishment of a war chest for financial crises, that is, a capital stock reserved for rescue measures. however, once this capital stock is depleted during a crisis, governments would again have to step in as lender of last resort. moreover, i have already hinted at the additional moral hazard problems that could result from such a funding solution. therefore, a more important supplementary measure would be the implementation of a special resolution regime for banks. such a regime would ensure that even large and systemically relevant banks could fail without triggering far - reaching disruptions within the financial system. the crisis has made it

banks would be obliged to contribute to a fund according to their risk structure and their systemic relevance. thus, just like the capital requirements under basel ii, a price would be placed on risk - taking, especially if it has a major impact on the system as a whole. however, in contrast to the capital held under basel ii, the resources that are contributed to the fund are lost to the individual banks. thus, the stabilisation fund puts an outright ( pigouvian ) tax on risk - taking in order to internalise the effects of risky activities on financial stability. as an ex post instrument to put a burden on the originators of the crisis, such a tax might be justified. nevertheless, as an ex ante steering tool, the proposed fund has major shortcomings. first, it would drain capital from banks. but, more importantly, it would not solve the moral hazard problem. as the fund would act as lender of next - to - last resort for failing banks ( the government would still have to step in if the fund ’ s resources were exhausted in a crisis ), the problem would merely be shifted from the level of government to the level of the fund. the banks, in fact, would still have an incentive to take on too much risk, while relying on the fund to cover potential losses. in the case of a european fund, the moral hazard problem might even be amplified, since costs that would normally occur at the national level could be shifted, at least partially, to the supranational level. a systemic crisis might even provoke a rat race among national governments for the fund ’ s limited resources. while the basel ii framework puts a shadow price on risk, and the stabilisation fund puts a tax on risk, a third proposal goes one step further. this proposal – a core element of what is known as the volcker rule – was proposed by president obama in mid - january. this rule aims at barring banks completely from certain forms of risk - taking : they would not be allowed to invest in or sponsor hedge funds or private equity funds. they would also be banned from engaging in proprietary trading operations for their own profit. thus, the risk of bank failures would be significantly reduced. at the same time, a cap would be put on the size of banks to reduce their systemic relevance. one shortcoming of the volcker rule, however, is that it most likely would not apply to investment vehicles, such as hedge funds or investment