This general constellation of market conditions and asset prices is unusual, at least in comparison to what we have seen over the past several decades. This has been a distinguishing feature of the present expansion, but it is not something we fully understand, and we cannot be confident in judgments about how durable it will prove to be. To a significant extent, these financial developments reflect a high degree of confidence in future macroeconomic and financial stability, reinforced by the improvements in inflation performance, growth outcomes and financial resilience of the past several years. Better monetary policy has lowered expectations of future inflation and inflation volatility and has contributed to lower risk premiums in general. Changes in the cyclical behavior of financial  BIS Review 2/2007  1  intermediation and credit provision, coupled with the increased stability of the real economy, seem likely to have reinforced the improvements on the monetary policy front. And rapid growth in the major emerging market economies, together with the substantial earnings of energy-producing and commodity-exporting countries, have produced a substantial increase in wealth and savings relative to perceived investment opportunities. In a world where capital can now flow much more freely across national borders, a significant portion of these savings has moved across national borders. These are powerful and fundamental forces, and they certainly help explain the broad reduction in risk premiums and the substantial demand for credit risk and financial assets. There are other factors at work as well, however, that have less favorable implications.

To this end, the Basel Committee has tabled an important set of measures aimed at increasing the financial system’s resilience in the medium and long term. These include most notably: –  Firstly, the proposal to increase the amount and quality of capital required of banks in order to enhance their loss-absorption capacity. The definition of capital will, moreover, be more transparent and internationally comparable. –  Secondly, consideration is being given to introducing minimum global liquidity standards and establishing common criteria to help supervisors identify and evaluate liquidity risk. –  Thirdly, work is under way to define various measures to mitigate the procyclicality of the financial system, which was not taken sufficiently into account in the pre-crisis period. Along these lines, the creation of countercyclical capital buffers has been proposed so as to contribute to reducing and not amplifying credit cycles. The aim pursued would be for banks to reinforce their capital during upturns and to be able to use it subsequently in periods of stress. In other areas, measures have been proposed to lessen the tendency of financial market participants to accentuate business cycles by their behaviour. Specifically, a series of criteria have been set for bankers’ pay in order to lessen their incentives to adopt risky, short-termist strategies. These have already been applied in the main developed economies. In the field of accounting regulations, too, significant efforts are being made to strengthen standards.