stanley fischer : financial sector reform – how far are we? text of the martin feldstein lecture by mr stanley fischer, vice chair of the board of governors of the federal reserve system, at the national bureau of economic research, cambridge, massachusetts, 10 july 2014. * * * although the recession in the united states that started in december 2007 ended in june 2009, the impact of the great recession, which began when lehman brothers filed for bankruptcy on september 15, 2008, continues to be felt in the united states, europe, and around the world. 1 after the bankruptcy of lehman brothers, policymakers, working through the g - 20, quickly reached agreement on the macroeconomic policies needed to minimize the damage done by the crisis. for their part, central bankers and supervisors of financial systems, working through the newly established financial stability board ( fsb ) and the newly enlarged basel committee, rapidly developed a program for reform of the financial sector and its supervision. in this lecture i will ask how much has been achieved so far in implementing the ambitious financial sector reform program that was widely agreed at the early stages of the global financial crisis. from among the range of topics in which financial sector reforms have been instituted since 2008, i focus on three : capital and liquidity for banks and other financial institutions, macroprudential supervision, and the problem of too big to fail ( tbtf ). what happened? the 2007 – 09 crisis was both the worst economic crisis and the worst financial crisis since the 1930s. following the collapse of lehman brothers, many thought that we were about to witness a second great depression. that did not happen, in large part because policymakers had learned some of the lessons of the great depression. nonetheless, the advanced economies were put through severe economic and political tests. fortunately, policymakers succeeded in dealing with the situation better than many had feared they would ; unfortunately, we are still dealing with the consequences of the collapse and the steps necessary to deal with it. former congressman barney frank has been heard to say that economists have a wonderful technique, that of the counterfactual, to analyze what has been achieved by preventing disasters, but that real people base their judgments more on the current state of the world than on disasters that have not happened. true as that may be, we should from time - to - time allow ourselves to recognize that as bad as the great recession has been, it would have been much worse had policymakers not undertaken the policies they did – many of

of the financial crisis, and has been declining since then in response to the significant steps made in the regulatory reform agenda. do large banks, with lower costs of financing, take bigger risks? the empirical relationship between bank size and their risk - taking has been examined by laeven, ratnovski, and tong, who find that “ large banks tend to have lower capital ratios, less stable funding, more marketbased activities, and ( to ) be more organizationally complex than small banks. ” 27 from this they conclude that “ [ l ] arge banks are riskier, and create more systemic risk, when they have lower capital and less - stable funding. [ they ] create more systemic risk ( but are not individually riskier ) when they engage more in market - based activities or are more organizationally complex. ” 28 the key to these results is the recognition that banks have several sources of financing, and that the more they rely on market interest rate - sensitive short - term funding, the less stable they are likely to be. organizational complexity is certainly an issue : maintaining managerial control, especially risk control, in a multi - activity bank, where individual rewards may be massive, is extremely difficult – think for instance of baring ’ s in the late 1990s, or societe generale, or the so - called london whale at jpmorgan chase. strong risk management is essential but faces the hurdle of the structural incentives for risk - taking implied by limited liability for individuals and by what may be a human proclivity to take risks. 29 but of course, banks that are heavily consumer deposit financed also fail from time to time, as a result of bad lending decisions. it could be that large banks can finance themselves more cheaply because they are more efficient, that is, that there are economies of scale in banking. for some time, the received wisdom was that there was no evidence of such economies beyond relatively modest - sized banks, with balance sheets of approximately $ 100 billion. more recently, several papers have found that economies of scale may continue beyond that level. for example, the title of a paper by joseph hughes and loretta mester, “ who said large banks don ’ t experience scale economies? evidence from a risk - return driven cost function ” 30 suggests that large institutions may be better able to manage risk more efficiently because of “ technological advantages, such as diversification and the spreading of information... and other costs that do international monetary fund ( 2014 ), global