The world's top banking supervisors gathered on Monday to review remedies to a crisis that has seen a major disruption of the global financial system and risks to global growth.
Regulators and central bankers at the Basel Committee on Banking Supervision will mull short- and long-term fixes that may, over time, change the way rapidly evolving financial markets are controlled, sources close to the committee say.
The Basel rule-setters will grapple with a host of challenges thrown up by the crisis that make their traditional task of ensuring banks have enough capital to cushion them in case of emergencies or shocks appear elementary.
"Capital is not the issue here -- rather, it is risk management or good corporate governance. And it's not just about the banking sector -- it's about the whole financial sector," said one source close to the committee. "It's a bit out of our hands."
Any conclusions drawn by the Committee, however preliminary, are likely to get great attention ahead of the G7 meeting of finance ministers in Washington later this month where the crisis, and ways to mitigate it, looms large.
New players such as hedge funds or sovereign wealth funds or non-bank actors such as U.S. mortgage companies have largely escaped regulatory scrutiny -- at least the degree of scrutiny applied to internationally active, systemically critical banks.
But they can wreak havoc, even among prudent banks, as the U.S. sub-prime mortgage crisis has illustrated.
Lessons from the crisis are still piling up, such as the run on British mortgage lender Northern Rock last month where the bank's lending business remained sound but its market access to funding dried up.
In the meantime, political pressure to act is rising ahead of the G7 meeting where a separate group of enforcers, the Financial Stability Forum, is expected to provide an analysis to finance ministers over what went wrong.
The FSF presentation is not expected to supply finance ministers with an action plan, rather an analysis that could provide the basis for new measures down the road.
Even before the crisis, regulators were pointing to weak spots in the system that -- once the crisis hit -- turned out to be exactly where the system stumbled, such as the way banks depend on one another for short-term funding.
Issues included banks' stress testing their risk models to see that they can still function under adverse circumstances, and securing back-up sources of funding when traditional lines dry up, valuations of illiquid assets.
"It's not just about capital any more -- just look at Northern Rock. There, it was a question of, Do I have the cash on hand?" the source said.
But the complexity of the analysis requires regulators dig deep or risk putting a quick but flawed fix in place. The Committee spent six years drafting the latest code of conduct for big, international banks, known as Basel II, which goes live in Europe in 2008 and in the United States one year later.
"It's too early to say whether Basel II works. Nobody on the Committee wants to rush to any conclusion about whether we have to fix Basel II. We want to try to understand things first," he said.
In the meantime, regulators on the Committee believe they have enough time to perform the proper analysis and sort out the right fix, rather than to attempt shoddy repairs.
"It's not like we're afraid that a systemically critical bank will fail or anything," the source said. "They have had sufficient capital and liquidity buffers to survive."