When it came to assessing risks to the financial system, unlike with monetary policy, there was no off-the-shelf model. In pursuit of one, I started looking to other disciplines for inspiration. From the mid-2000s, I began discussion with a set of scientists – physicists, evolutionary biologists, epidemiologists – on the models they used to understand complex, adaptive systems. I was hoping they might provide some analytical clues when it came to modelling the complex, adaptive world of finance.
I was in luck. There was a well-developed field of complexity science, with applications in most of the natural sciences and some of the social sciences. Economics and finance was a notable exception. Once I had retro-fitted these models to the financial system, I wrote a note and sent it to the Governors in 2005. It was titled “Public Policy in an Era of Super-Systemic Risk”. It made some bold claims about financial system resilience, most of which jarred with the prevailing orthodoxy.
Financial integration, it argued, was a double-edged sword. It was fantastic for risk-dispersal when the good times rolled. But interconnections could switch from friend to foe when shocks were large. Connectivity then amplified, rather than dispersed, risk; it spread contagion. The more connected the system’s nodes – the larger the number of “super-spreaders” - the greater this fragility. This “robust-yet-fragile” property of complex webs struck a cautionary note about the true stability of modern finance.
When it came to managing systemic risk, complexity science was rich in answers too. In avoiding fragility, one effective solution was to ring-fence activities, the financial equivalent of fire-breaks, to contain contagion. A second solution was to focus on inoculating, or risk-proofing, the super-spreaders to prevent them serving as a conduit for contagion. And a third was to manage emergent aggregate risks to the system by explicitly leaning against the risk cycle, moderating its emerging excesses.
I am still waiting for comments on my 2005 memo. With hindsight, one of my career regrets was not to make more of the results until it was too late. This framework did, nonetheless, prove useful after the global financial system went into meltdown in 2008. The robust-yet-fragile property of modern finance was then laid bare. The double-edged sword of financial integration did then cut through the financial system. And super-spreaders did suddenly appear on our high streets, as people queued in the streets for their money.
None of this is to suggest that me or anyone else foresaw the true horror of the Global Financial Crisis. As best I can tell, no-one got the crisis completely right, despite a number of people subsequently exhibiting supernatural powers of hindsight. Rather, the crisis illustrated the limits of our collective knowledge, our collective lack of imagination. It demonstrated that, in a world of uncertainty as distinct from risk, it is better to be super-safe ex-ante than super-sorry ex-post, better to be roughly right than precisely wrong.


The centrepiece of these banking reforms was so-called Basel 3, overseen by the Basel Committee on which I sat. The Basel 3 reforms eventually resulted in significant increases in the amounts of capital banks held; the introduction of an international regime for leverage and liquidity; a capital surcharge for the world’s “super-spreader” banks; and a system of counter-cyclical capital regulation to modulate credit cycles. These reforms bore more than a passing resemblance to the solutions complexity scientists might have proposed.
A new word emerged to capture these reforms - macro-prudential regulation. The macro signalled two important ideological shifts from the past. First, banking needed to be managed at the level of the system as a whole, like any other eco-system. Second, as important as the resilience of the financial system was its interaction with the macro-economy to avoid adverse feedback effects between the two, such as credit crunches. Finance was to be servant of the economy, not master. This, truly, was a regulatory revolution.
Not all proposals for international regulatory reform found universal favour. In a paper prepared for the Jackson Hole central banking shindig in 2012, I questioned whether the very complexity of financial regulation might have contributed to the increasing fragility of the financial system. As you did not fight fire with fire, you did not fight financial complexity with regulatory complexity. That risked making a bad situation worse, a complexity problem squared rather than halved.