. the recent system outage at the bank of england that disrupted the operation of the uk ’ s large value payment system, chaps, provides a further example of how widely a payment system disruption can be felt. the unavailability of chaps for nine hours meant that high value sterling payments, including the settlement of house purchases, could not proceed, causing a gridlock of house settlements. more seriously, the settlement of foreign exchange transactions around the world was disrupted because the functioning of the cls system depends on the ability to make and receive payments in all currencies in cls, including sterling. the greatest potential for systemic damage from payment systems arises in the event of a failure of one or more major counterparties to financial transactions, particularly derivative transactions. in physical foreign exchange and securities transactions, the use of delivery versus payment ( dvp ) removes credit risk from the payments process. but financial derivatives involve ( sometimes long - dated ) future commitments to exchange cash flows that vary with market prices. the posting of collateral is used to reduce credit exposures as derivative contracts go in and out of the money over time but this is an imperfect process, particularly in times of market turbulence. the failure of lehman brothers and aig in 2008 – 09 focused the spotlight on the huge extent, and also the opacity, of credit exposures arising from over - the - counter ( otc ) derivatives 2. the us authorities were ultimately able to untangle the lehmans derivative book without further major contagion. in the case of aig, a bailout was organised by the us treasury in order to avoid the further financial fallout that would have ensued if aig had been unable to meet its obligations on its large volume of derivative contracts. an additional area where we face growing risk management challenges is the increasingly global nature of the infrastructures that provide many wholesale payment services. in new zealand we already rely on a number of offshore fmis. these large global financial infrastructures provide advantages in terms of economies of scale but also pose legal and resolution risks for local counterparties in the case of an fmi failure. the outcome for a domestic bank would be determined by the legal and regulatory framework in the fmi ’ s home jurisdiction, over which new zealand authorities would have little influence. swift is the principal global messaging system used in payments systems. derivatives bought and sold through banks, rather than exchanges. bis central bankers ’ speeches responses to increased risk what are the appropriate responses to these increased

the risks of sovereign bonds and for exposures to sovereigns to be covered by the usual large exposure rules. however, these reforms will only be finalised after 2016. 6. reforming business models ladies and gentlemen, rules must be developed, reviewed, accepted and implemented. banks and savings banks will probably adapt their organisations in the very same way for years to come. as a former banker myself, i can understand that these costly and challenging processes can be frustrating, especially for those working at banks that played little or no part in the excesses prior to the crisis. but we must not forget that the processes in question are transitional and involve high oneoff costs and greater compliance expenses in the long term. in the light of the important role of credit institutions in the economy, they are absolutely justified. many of the problems stem less from regulation but more from the fact that some institutions are still clinging to their old business models despite finding themselves in a new world. but the old world of unlimited financial markets has gone – for good. like many other european banks, some german institutions are still searching for business models that are competitive, viable, and yet sustainable. this is clear, among other things, from the fact that german credit institutions have the poorest cost - income ratio in the eu, and also lag behind in terms of other profitability ratios. however, i won ’ t pretend that finding the solution to this problem is simple. after all, profitability cannot and must not focus on the short term. that was, in fact, one of the causes of the most recent financial crisis. sustainable business models must be well - conceived and must also enable banks to weather difficult phases. if credit institutions change their strategic focus as a result of the new rules, as we have actually already seen in a few cases, this is not necessarily a negative side effect of regulation or proof that the regulators have overshot their mark. it may actually be proof that the new regulation has achieved its aim – to encourage banks to adopt sustainable business models. 7. conclusion ladies and gentlemen, since the 2008 global financial crisis, regulation has been significantly tightened all over the world. are the costs of regulation excessive? without a doubt, they are significant. but if we analyse the costs and benefits to society, the outcome is clear : compared to the costs of a crisis, the costs of regulation are an appropriate price to pay for greater stability. and what is more, bis central bankers ’ speeches effective regulation not only increases