These capital flows—a significant portion of which are non-resident activities—are more sensitive to global financial conditions which have been dictated largely by monetary policy stance of AEs and global investors’ sentiment rather than textbook-determinants like macroeconomic conditions in EMs and interest rate differentials. Moreover, due to the large foreign-exchange activities by non-residents relative to the size of domestic foreign exchange markets and increases in derivatives and algorithmic foreign exchange trading activities, exchange rate could at times act as an amplifier as opposed to a stabilizer of shocks and capital flows, especially in EMs with strong external positions that are considered as safe haven like Thailand. While capital flows in and out of EMs might be small relative to global financial activities, they could have real and significant impacts on the EM economies through the exchange rate channel. Concerning volatile exchange rate movements that could undermine financial stability, capital flows could affect EMs’ monetary policy stance. For example, in the low-for-long interest rate environment, EMs may need to follow AEs in delaying or reversing normalization of monetary policy to avoid appreciation of their currencies. Because of spillovers, monetary policy of EMs could be distracted from their core domestic policy mandates. The delayed normalization in the low-for-long or negative-for-long interest rate environment further exacerbates financial stability risks. Debts—both household and corporate— are now reaching historic highs. Emerging nations, often with nonbank financial activities outside the regulatory perimeter, are more susceptible to risk buildups. Financial spillovers need to be addressed at multiple levels.

Working with the Bank of England’s Resolution team, the PRA will need closely to integrate recovery and resolution planning within its supervision; and in my view should embed a proactive intervention framework akin to the US Prompt Corrective Action within its supervisory approach to deal with the inevitable situations where firms get into the danger zone. Above  2  BIS Review 121/2010  all, these tools should support competition in the industry, by accepting that there will be winners and losers. In two years’ time, we will have a new system of financial regulation in the UK. Those of us involved can assure you that the transition is not a small task, but I can also assure you that the Bank is fully committed to working with the FSA to ensure a smooth transition. There is a great deal to be done to implement the new system of regulation, to articulate and build the public interest in financial stability, and thereby to improve the stability of the system itself. Basel III, macroprudential tools, countercyclical buffers, are all things that Adair and I get excited about. They are important foundations of good policy. But on their own they don’t win the public interest argument for financial stability. To do that, we have to build the case that the industry will serve the needs and interest of the public. The authorities cannot do this alone. Building confidence in the financial system takes effort and time. It is a common goal and in the interest of everyone.