Sound corporate governance at the firm level is the first bulwark against financial system instability, and begins with capable and experienced directors and management, a coherent strategy and business plan, and clear lines of responsibility and accountability. The execution of overall objectives must be supported by rigorous internal controls and effective risk management. The importance of a strong institutional credit culture cannot be stressed enough. Strong private balance sheets contribute to a strong national balance sheet. Recent experience underscores the importance of prudent management of liquidity risk. Clearly, reducing public sector short-term borrowing is often an essential (and generally well-acknowledged) part of the solution. To encourage improved private sector liquidity, authorities need to review the broader policy mix and identify and remove incentives that favor excessive short-term capital flows, as well as identify and remove barriers to longer-term and/or equity capital flows. The second line of defense is effective market discipline, an increasingly important ally of policymakers in a global marketplace. Of course, market discipline must be supported by substantial disclosure, sound accounting standards, and an efficient and credible legal framework. On the last point, while some foreign investors have too frequently made allowances for “special” local practices during periods of economic boom, only strong and proven attitudes towards law, taxation, disclosure and the like provide the kinds of protections most long-term investors want and should insist upon.

•  Unbalanced financial systems create vulnerabilities. Financial systems that are unduly reliant on banks for financial intermediation are likely to be more vulnerable and slower to  3  BIS Review 57/2000  recover from the onset of weakness. Shallow capital markets limit lending alternatives and delay the recovery of financing to the real sector. The challenges can be daunting, but recent experience both within and beyond Asia confirms that a dedicated commitment to financial reform contributes to greater crisis-resilience and longer-term financial stability. While financial sector rehabilitation will remain a key priority for authorities in Asia, longer-term measures need to be put in place to deal adequately with the increasingly complex and dynamic international financial marketplace of the 21st century. The threats to financial stability are many, and no one set of measures can be expected to ensure against the recurrence of future problems. Financial intermediation is a constantly evolving activity, involving new risks, instruments and control challenges. Financial institutions and policymakers alike need continually to upgrade their processes to remain in command of these risks. To that end, it is imperative that new standards not be developed to “fight the last war”, but be sufficiently robust to meet new challenges in a dynamic way. Stability ultimately can be served only by the collective interaction of the three pillars of: •  sound leadership at the firm as well as at the national level;  •  effective market discipline; and  •  strong prudential regulation and supervision.