can we draw from this? the combination of excess lending with an obvious failure to adhere to fundamental and sound risk management standards not only produced significant losses in mortgage portfolios ; it also tainted an asset type that was key in the broader securitisation and credit distribution process. the reckless use of the originate - to - distribute model increased uncertainty regarding credit quality, where risk resides and the impact of deterioration. this heightened uncertainty suggests that in maintaining their capital buffers – the dikes – banks need to do a better job capturing the risks related to this business model. we have to build higher dikes but must not forget the importance of building on a sound foundation, which is high quality capital. basel ii provides the necessary framework within which to achieve these enhancements. i will return to the capital issue in a moment. liquidity liquidity was another victim of the current storm and its demise holds valuable lessons for supervisors. increasing banks'liquidity cushions and improving liquidity risk management and supervision has been an area of sharp focus for the committee. we have seen massive illiquidity in certain market segments ( especially complex structured products ) for a much longer period than any market participant would have predicted. complex and illiquid investor - specific instruments, such as resecuritisations, have experienced significant marketvalue losses, which has led to the loss of confidence in their financial worthiness and the drying up of liquidity in the short - term interbank market. the recent turmoil has shown that banks must strengthen their liquidity buffers. one way to do this is to increase their holdings of high quality liquid securities – in particular, liquid central government securities. the committee ’ s guidance on sound liquidity risk management and supervision and vigorous supervisory follow - up will help raise the bar in this area. we will continue to examine the topic of liquidity with a focus on cross - border aspects of liquidity supervision. while liquidity risk cannot be mitigated with capital, capital is itself a form of liquidity since, unlike other liabilities, it does not have to be repaid. furthermore, a strong capital buffer enhances a bank ’ s creditworthiness and, from the market ’ s perspective, reduces its counterparty risk. this helps to ensure continued access to funding. capital adequacy and this brings me to the issue of capital adequacy. after several years of high profits, often record profits, we know that the level of risk was grossly

underestimated by many financial institutions. this latest storm has therefore revealed cracks in the dikes and the supervisory community is in the process of patching up those cracks. high losses have put pressure on capital cushions and many banks have been forced to go to the market to replenish their capital base. this is critical if a contraction in lending and credit are to be avoided. of greater importance, though, are the cracks in the dike that are not yet evident. while we do not know the nature and strength of the next storm, we can take measures today to strengthen the dike so it could withstand the battering. one of those measures is to significantly strengthen banks ’ capital buffers. in addition to moving ahead aggressively with basel ii, the committee has issued a proposal to strengthen the capital treatment for risks not captured under basel ii ’ s existing trading book regime. in this context, the committee is also carefully considering the topic of procyclicality, especially as it is influenced by bank capital issues. there are many dimensions here, such as the level and quality of capital ; provisioning, capital buffers and the ability of banks to dip into those buffers. we will continue to review these and other issues related to procyclicality and are in the process of developing a work programme to address both near term and longer - term issues. the committee is also developing enhanced guidance under pillar 2, the supervisory review process. here, our focus is on improving risk management practices, such as stress testing and the management of risks arising from complex instruments, among other things. we are also developing proposals to strengthen pillar 3 disclosures, especially for securitisation activities. conclusion we have learned much from the severe storm that is currently raging. i have outlined some of the measures that banks and supervisors must take to better prepare for the next storm. but what is becoming increasingly clear is that, over time, the banking system needs to strengthen capital and liquidity buffers to withstand prolonged periods of stress in the financial system and the broader economy. this will be done in a manner that does not aggravate the current stress in the system. enhancements to risk management and market transparency will help, but we must enhance banks ’ buffers to reflect the increased degree of uncertainty in the system. the need for increased margins to protect against uncertainty will also become apparent as rapid financial innovation continues and uncertainty increases about how new products, valuations, markets and the real economy will interact