On top of this, there is also uncertainty whether a larger impact could materialize because of the potential for catastrophic damages. Given the performance of the financial sector is closely related to the macroeconomy, implications for the financial system could be significant through increased exposure of the financial system to risk, both its own and through its clients, as well as possible damages to its assets. The key risk-driver includes market risk linked to large economic disasters, and operational, reputational, political, legal and counterparty risk relating to defaults after a disaster. In  BIS Review 97/2008  1  addition, there is also a business risk if it fails to properly incorporate climate change into its portfolio risk management. As for threat to financial stability, this would depend on whether the impact is slow-moving, which can be offset by risk-management, adaptation, and financial response. Alternatively, the impact could take the form of a series of catastrophic events that impair the operative capacity of financial institutions. Second, being a global problem, the collective response to climate change can set off an economic transformation, in terms of the changing patterns of demand and production, toward a low carbon economy that will require the financial system to adapt by managing risk and exploring related business opportunities. Three triggers will be key in driving this transformation: namely, regulations set by the government, response by the private sector through adaptation and mitigation, and increased public awareness of the issue.

It is notable that countries, such as Korea, which had very significant amounts of reserves prior to the crisis and a flexible exchange rate regime, nevertheless felt the need to enter into currency swaps with the Federal Reserve. During the crisis, foreign exchange reserves were used as a tool for internal – as well as external – financial stability. National central banks, especially in Latin America, acted as dollar lenders of last resort to their domestic banks. This function will develop in the future and is bound to impact the demand for reserves. Financial openness and integration means that domestic banks will engage increasingly in foreign currency operations. In turn, the expansion of international balance sheets will increase the potential demand for liquidity support in the event of shocks. This trend should be accepted as a normal consequence of open capital markets and international banking, together with the predominance of a very limited number of currencies in international finance. One general lesson can be drawn from that experience. In the current environment, there is an inescapable trade‐off between financial openness, on the one hand, and the need for protection against external financial volatility, on the other. An essential question for the future is whether we can improve this trade‐off and avoid the costs and distortions associated with growing amounts of foreign exchange reserves and/or further restrictions on international capital mobility. International financial stability: what should be done? Looking at the next decade, a number of different developments in the international financial system are possible.