While financial liberalisation and international financial integration bring unquestionable benefits, they can also be subject to episodes of excessive risk-taking. In recent years, there does seem to have been imprudent lending, and not just to emerging market economies but also to borrowers within the industrial world. In part this has been spurred by competitive forces. That such forces will diminish as financial restructuring accelerates seems unlikely. However, the potential of public safety nets to distort incentives and breed complacency can also be discerned and these structures should be re-evaluated. It is important that all investors are held accountable for their decisions. The international community should also ensure that all investors and lenders play their part in the resolution of any future financial crisis and, to this end, should implement, inter alia, changes to international bond covenants that would facilitate debt restructuring should this become necessary. The events of the past decade have made it clear that greater efforts are needed to strengthen the functioning of markets. Information asymmetries lie at the heart of market failure, and the market’s way of resolving them can give rise to unpredictable outcomes. Ensuring that markets have adequate information about national economies, the strength of financial systems, aggregate positions and the financial standing of counterparties is important. Equally, if not more, important is to ensure that market participants’ approach to risk management reflects the full balance of costs and rewards implied in their decisions.

Domestic policies, institutions and rules, important factors behind crises … Although several of these factors may have played some part in the run-up to recent financial crises, it is important to bear in mind that financial crises almost always originate in an unsuccessful domestic economic policy and in the structure and regulation of the domestic financial system. While modern international financial markets have possibly contributed to an earlier appearance of crises and to their spreading, a deregulated financial system with free capital movements as such is not the basic problem. It is striking that several countries most affected by financial turbulence in the 1990s were relatively new participants in the international financial system without having first established a sound domestic financial system and a sound economic policy. That conclusion also holds for my own country, Sweden, which experienced a severe crisis in the early 1990s. One obvious insight is, and I quote Fed Chairman Alan Greenspan, “that participation in the international financial system with all its benefits carries with it an obligation to maintain a level of stability and a set of strong and transparent institutions and rules if an economy is to participate safely and effectively in markets that have become highly sensitive to misallocation of capital and other policy errors”. Thus, emerging market economies must reform their domestic financial systems, just as we did in Sweden after our crisis, if they want to enjoy the benefits of an open international financial system.