paul tucker : the debate on financial system resilience – macroprudential instruments speech by mr paul tucker, deputy governor for financial stability at the bank of england, at barclays annual lecture, london, 22 october 2009. * * * what stage have we reached in the current financial and economic crisis? the stage where the most hideous macroeconomic nightmare – a second great depression revisited – is now probably remote but where the outlook remains highly uncertain by any normal standard. where the banking system is recovering, but where some big uk ( and overseas ) banks have a lot left to fix. and where there has been real progress with many policy initiatives to make the international financial system more resilient in future, but where perhaps some of the biggest issues remain unresolved, even incompletely articulated. after some scene setting, i will address one of those issues this evening : whether there might be macroprudential instruments that could lean against and preserve banking system resilience in the face of credit boom and bust. i will also provide an update on international plans for banks to produce recovery and resolution plans, known here as living wills. the macrobackdrop and the credit system at the beginning of this year, 1 i thought it would take until the autumn at least to tell whether the economy was going to lurch downwards into a spiral of falling prices, rising real debt burdens, generally enfeebled banks and falling output. while absolutely nothing can be definitively ruled out, that nightmare now seems unlikely. i shall weigh that in my own policy considerations, as for me the size of the massive monetary stimulus has partly been designed to insure against that catastrophe risk. so a key question over the coming period will be whether or not conditions are developing where some of that insurance could be withdrawn, consistent with leaving policy highly stimulative. 2 but the economy has in actual fact been very weak, with output falling and unemployment rising. the policy debate in the months ahead therefore will turn, as more usually, on the broad outlook for the risks around inflation over the medium term. that will depend on the data and, in particular, whether the data and surveys about real activity and demand come more closely into line, here and overseas. one of the biggest questions is whether, given the policy stimulus, recovery will be anaemic or whether we can attain the above - trend growth needed to absorb the slack in the economy necessary to ameliorate downward pressures on inflation. this will

in a democracy, political constraints are uncertain and so even too big to fail firms can sometimes be allowed to fail. banks need a system in which they are better protected against mismanagement by their peers. the debate calls for technocratic solutions to be laid out, but choice amongst those solutions should be understood and accepted by society at large. and the solution needs to be an international one. it is therefore good news that the g20 has commissioned work from the financial stability board on the too big to fail issue. so the stakes are high. by the lights of our successors, we are bound to get it wrong, but can we get to the right ballpark? reforms to the “ how ” approach to the banking system oversight the governor of the bank said earlier this week that we face a choice between an overhaul of the regulatory regime and directly altering the structure of the banking system. as earlier policymakers would have put it, this is a choice between, on the one hand, regulating what banks and other financial firms can do and, on the other hand, leaving open the scope of what they may do but regulating and supervising how they do it. since the thoughts on macroprudential instruments i shall go on to outline this evening are based on something like the existing structure of the banking system persisting, i shall briefly recap what i have said in a series of speeches earlier this year about the current reform agenda. 3 the three necessary planks are re - regulation and a return to supervision ; for the first time, agreeing effective resolution plans with banks and any other key firms ; and, i would hope, a clear capital of last resort regime designed to avoid perverse incentives. see “ remarks by paul tucker ”, panel session at the fsa ’ s turner review conference, 27 march 2009, “ the repertoire of official sector interventions in the financial system : last resort lending, market - making, and capital ”, tokyo, 28 may 2009, and “ regimes for handling bank failures : redrawing the banking social contract ”, at the british bankers ’ association annual international banking conference : restoring confidence – moving forward, 30 june 2009. traditionally, in exchange for being allowed to profit from taking risks inherent in providing liquidity, or monetary and credit services to the economy, banks have been subject to : prudential regulation ; given access to liquidity insurance at the central bank ; and required to finance industrywide insurance schemes. those have been the key elements of the social contract for