more equity capital in terms of the present value of all future falls in output. this is the methodology used in the calculations reported in the bank of england ’ s 2010 financial stability review ( fsr ). those calculations were based on conservative assumptions – understandably so, for fear of under - estimating the cost to the wider economy of imposing substantially higher capital requirements on banks. i will start from that fsr baseline estimate of the present value of output lost as a result of a 1pp increase in the capital ratio, which is 4. 25 % of current annual gdp. that estimate becomes very substantially smaller if we make less conservative assumptions and allow for several offsetting impacts from banks holding more capital. specifically : 1. allowing for a partial offset because as a bank holds more equity capital, its equity becomes less risky, and therefore requires a lower return. ( a modigliani - miller effect – which i will assume is not zero but only 30 % as big as it would be under perfect markets ) 2. allowing for the value to the government of the extra tax revenue received as a result of banks having more equity capital which is less tax sheltered than is debt. 3. allowing for a somewhat lower use of bank funding for investment than in the baseline. 4. allowing for a lower sensitivity of investment and the capital stock to a rise in the cost of funds to non - financial firms. table 2 shows how rapidly the estimated long - run economic cost of requiring higher bank capital falls as we sequentially allow for each of these offsets. i conclude from this that the long - run costs of having banks hold more capital is likely to be small – plausibly it is negligible. if that is so then the benefits of having much more robust banks would far exceed its costs. if it is right that the benefits of raising capital requirements to much higher levels far outweigh their economic cost, how we did we get into a situation that bank capital was so low relative to total assets? i think this is because banks and regulators came to believe capital was very costly. in particular the modigliani - miller ( m - m ) offset ( that equity becomes less risky, and so less expensive, as gearing falls ) was ignored. a failure to understand the exact details of the m - m theorem is of course understandable – it is a theoretical result and one which was originally described in an academic article. but it was – and remains – surprising to me that the

is to improve transparency, simplicity and consistency so that investors can understand the risks associated with securitisations. for simple, transparent and consistent securitisations, we are prepared to review whether post - crisis regulatory requirements for investors and originators are too onerous. that includes solvency ii, where we welcome a recalibration of capital requirements for such simple, transparent and consistent securitisations, particularly at longer maturities. the bis central bankers ’ speeches ongoing participation of insurers – a major source of long - term finance – in this debate will be key to achieving results. we have got to a stage now where the path to solvency ii is clear. we have come a long way from the uncertainty that has seemingly dominated the past few years. but we need to remain conscious of the new challenges and opportunities that are on our horizon. alongside the european process the wheels have been turning in the international space. a common set of global standards for systemically important insurers are being worked on as we speak. throughout the development of these standards, the bank of england will continue with its strong history of international engagement. we have made great strides in europe with solvency ii and we aim to ensure the complementarity of upcoming global standards with what we have achieved with solvency ii. continued interaction with the industry is an essential part of good policy making so i ’ d like to again thank you for your participation today. i hope that we can continue to work together towards achieving a policy outcome at all levels that fulfils our objectives and in turn ensures the stability, resilience and ultimately the prosperity of the insurance sector in the uk. bis central bankers ’ speeches