daniel k tarullo : the evolution of capital regulation speech by mr daniel k tarullo, member of the board of governors of the federal reserve system, at the clearing house business meeting and conference, new york, 9 november 2011. * * * a little over three years ago, lehman brothers ignited the dry tinder of a badly overleveraged financial system that was too dependent on continuous, significant increases in housing prices and too opaque for supervisors, investors, analysts, and often participants themselves to understand. as one would expect of a truly systemic crisis, there were many contributing factors – the prevailing statutory framework for financial regulation, supervisory practices, and the risk - management practices of financial actors. and, as one would thus expect, the reform agenda has itself also been multi - dimensional. for all the regulatory changes that are in place, in process, or under consideration, however, i believe that capital regulation remains the single most important element of prudential financial regulation. let me immediately elaborate upon that statement in two ways. first, capital regulation itself must be multi - dimensional and rigorous in each of its components. second, while strong capital regulation is necessary for a sound financial system, it is not, on its own, sufficient. in my remarks this afternoon, i will concentrate on the first of these points and discuss how capital regulation reform is evolving in the wake of the crisis. evolution and shortcomings of capital regulation although they had long used bank capital ratios as a supervisory instrument, u. s. bank regulators did not impose explicit minimum capital requirements until the 1980s. the proximate reason for this change was regulatory concern over the decline in capital ratios of the largest banks – a concern reinforced by congress, as it saw some of those large banks facing enormous losses on their loans to foreign sovereigns. within a few years this u. s. regulatory innovation was effectively internationalized by the original basel accord. at the same time, regulators came to regard capital requirements as a supple prudential tool. as activity and affiliation restrictions were loosened in the united states, capital requirements seemed a promising way to protect the public ’ s interest in the stability of financial institutions that had access to the federal reserve ’ s discount window and federal deposit insurance corporation insurance. capital requirements promised to provide a buffer against bank losses from any activities in which the bank or its affiliates might engage, a consideration of equal or greater relevance in countries with universal banking models. some support also developed for the proposition that

list of systemically important banks and the assignment of those banks to the various surcharge buckets. in both arenas it is important to move as quickly as feasible to complete all this work, so as to provide more clarity to banks, markets, and the public on the details of capital requirements, while still ensuring that the final regulations and requirements are well - crafted. but if details are still lacking, the direction of these reforms is now clear. when fully implemented, these reform strands together will increase significantly the safety and soundness of the financial system and make much less likely the need for some future tarp. at a time when there is considerable disagreement over the best direction for many aspects of financial regulation, that result is one i suspect commands broad support among policymakers, policy analysts, and the public. bis central bankers ’ speeches