Clearly, Asian economies have benefited much from such capital inflows, but at the same time they have exposed themselves to the threat of a sudden loss of market confidence and hence large outflows of funds due to policy mistakes or shifts in the international economic environment. This is particularly true if a large proportion of inflows are volatile portfolio investment or short-term borrowing. 24. The next monetary problem concerns current account deficits. A number of Asian economies were able to run larger than normal current account deficits in the balance of payments because they were easily funded by capital inflows. The bad news about large capital inflows is that they might allow investment and even consumption to expand without enduring the pain of overheating or loss of competitiveness. Higher levels of domestic credit, consumption, investment, growth and even budget revenues can be sustained at the cost of rapid accumulation of foreign debt. To make matters worse, over 80% of the current account deficits of selected Asian economies was funded from short-term bank debt. In hindsight, the ready availability of short-term external financing might have delayed the necessary policy adjustments in face of cyclical and structural changes in the domestic and international economic environment. In short, we can all easily make the mistake of taking capital inflows for granted. 25. Then there is asset price inflation which is a rather common consequence of capital inflows. In an open economic environment, capital inflows may not lead to consumer price inflation, since imports would alleviate excess demand.

Once linked up, Herstatt risk of foreign exchange transactions involving the two currencies concerned will immediately be eliminated. Payment versus payment (PvP) and delivery versus payment (DvP) within Asian time will become a reality. 57. The fourth area for Asian monetary co-operation is banking supervision and financial regulation. As financial markets are further liberalized and integrated, the growth of cross-border banking activities and other financial transactions is accelerating, increasing the risk of contagion. As ultimately monetary problems surface in the banking system, it is important for regulators in different economies to co-operate to safeguard the integrity of the banking and financial systems in the region. Part of the work will involve the harmonization of supervisory practices, including the adoption of the Core Principles for effective supervision advocated by the Basle Committee. 58. Through working closer together, such as the collaboration of the EMEAP Study Group on Banking Supervision, supervisory authorities in the region would be able to improve their understanding of each others’ banking systems and supervision framework and approach. We will also review practices in the region against the existing Basle Committee benchmarks, identify reasons for any differences and thus help to raise the quality of supervision in the region. Over time, it may be possible to move on to the setting of standards. 59. Last, but not least, in Asia monetary co-operation concerns policy consultation. Clearly, there is scope to improve mutual understanding of each other’s policy framework and priorities.