Another striking feature is the fact that the international flows are currently dominated by private capital, which is in sharp contrast to what is has been two or three decades ago when official capital flows used to play a key role. This trend has been greatly supported by the liberalisation of capital flows, both in the advanced countries and in the emerging markets. The belief has prevailed that in a long run, free movement of capital is welfare enhancing, as it leads to more efficient allocation of capital, faster economic convergence of less developed countries, better consumption smoothing, and diversification of financial portfolios. Even though these benefits are undisputed, free capital mobility has also created many challenges. On the macroeconomic level, for example, we have observed many currency crises followed by painful stabilisation periods. These crises have often been preceded by periods of fast capital inflows, aggravating vulnerabilities in the domestic financial sectors of the emerging market economies. These financial weaknesses have then functioned as an important transmission channel for macroeconomic shocks, leading to “twin crises”, i.e. a vicious circle of currency depreciations and failures of financial institutions. The Asian crises in 1997-1998 and the recent experience of Argentina are examples of such modern twin crises. Another challenge related to the massive and liberalised capital flows lies in the area of international fraud and money laundering. The detection of such activities is a crucial preventive policy objective. Money laundering enables criminal activities to grow and cause further damage, the most serious case being terrorist financing.

It also leads to potentially high moral and reputational costs for the financial system and for society at large. Finally, it generates inefficiencies and volatility in the allocation of resources, as launderers move their funds not in response to economic rationale, but in an effort to disguise the origin of their money. In the end, this runs counter to the desired benefits of financial liberalisation. However, in an environment where private capital moves quickly from one country to another without any permission being required, seeking the best short-term returns, it is naturally more difficult to detect fraudulent or money-laundering transactions. The environment is also made more challenging by the growing sophistication of financial products in the liberalised and globalised markets and by frequent use of off-shore centres for tax-optimisation purposes. The ongoing financial innovations and recent negative experience have led to a widespread conviction that the international policy and financial architecture needs to be strengthened. Moreover, it has become widely understood that regulation must be co-ordinated internationally, as tightening it in only some markets and/or countries might merely shift the negative phenomena to other places, without reducing their overall severity. There have been numerous suggestions pointing in this direction, the most ambitious of which include proposals to establish a global lender of last resort and/or a supervisor. So far, however, the actual solution has been the creation of a comprehensive set of international standards and recommendations by international organisations.