The best way to control risks is the market incentive to do so. For the market to work, there must be adequate information transparency, and an adequate pay (or penalty) structure that causes the private sector or market to regulate itself. For example, excessive bonuses may have caused the Barings management to overlook the risks assumed by Leeson. Low pay for internal auditors relative to dealers may prevent them from raising the alarm bell. Internal audit committees of financial institutions should signify that they have considered the implications for the risk preferences of key personnel of their pay structures. It is now better recognized that a robust financial infrastructure is also a form of regulator on market participant behaviour. Modern financial infrastructure, such as automated payment systems, impose on market participants certain minimum standards of performance, such as time compliance in payments. Failure of one participant to perform would immediately expose the participant to market discipline. There is therefore peer pressure on market participants to comply with the standards demanded by international payment systems. Costs of Regulation Regulation is not without costs. The US estimates that regulation costs the consumer roughly 7% of GDP annually, both directly or indirectly. Bank regulation can be likened to deposit insurance - the higher the regulation and safety, the higher the insurance premium. One theory suggests that banks can elect to be one of three categories: super-safe banks, safe or normal. Super-safe banks are only allowed to hold super-safe assets, but in return have 100% deposit insurance.

References: Bank for International Settlements, “Report on Financial Stability in Emerging Market Economies”, April, 1997 Bullock, Alan, Stallybrass Oliver and Trombley Stephen, The Fontana Dictionary of Modern Thought, Fontana Press, 1988 Commonwealth of Australia, “Financial System Inquiry: Final Report Overview” - the Wallis Report -, Australian Government Publishing Service, March 1997 Dale, Richard, Regulating the New Financial Markets, Proceedings of a conference “The Future of the Financial System” held at the H.C. Coombs Centre for Financial Studies, Kirribilli on 8/9 July 1996, Economic Group, Reserve Bank of Australia Davies, Howard, Market and Regulatory Structures in a Global Environment, speech at the Federal Receive Bank of Atlanta’s Financial Markets Conference, February 1997 Goodhart, Charles, Some Regulatory Concerns, LSE Financial Market Group, An ESRC Research Centre, Special Paper No. 79, December 1995 Greenspan, Alan, Remarks at the Spring Meeting of the Institute of International Finance, Washington DC, April 1997 Hoenig, Thomas M., “Rethinking Financial Regulation”, Federal Reserve Bank of Kansas City, Economic Review , Second Quarter 1996, Vol.81, No.2  BIS Review 55/1997  -9-  Lindgren, Carl-Johan, Gillian Garcia, and Matthew I. Saal, “Bank Soundness and Macroeconomic Policy”, International Monetary Fund, Washington, DC , 1996 Sheng, Andrew, “Bank Restructuring: Lessons from the 1980s”, World Bank, 1996 Sheng, Andrew, “Managing Derivative Market Risks”, Hong Kong Monetary Authority, January, 1997 The Palgrave Dictionary of Economics Footnote: I am grateful to Carmen Chu for research assistance in the preparation of this paper and to Raymond Li and Osbert Lam for useful comments. BIS Review 55/1997