The Bank will also close the foreign currency accounts of deposit banks it has held. Since 1987 the Central Bank has targeted interest rates to achieve its monetary policy objective rather than targeting the money supply or base money. The access that deposit banks have to liquidity at the Central Bank is therefore flexible and at their own discretion, with the Bank’s interest rates among the factors influencing the extent to which the draw on liquidity from the Central Bank. At the outset, the long-term market was most important to the Central Bank but as the money market and the foreign exchange market developed during 1992 and 1993, the Bank began to focus its activities on them. The Central Bank’s instrument rate is now the yield it requires on repurchase agreements with credit institutions. This arrangement is similar to the most common practice among industrial countries, and is based on the premise that central bank instrumental rates largely determine money market rates. Money market rates then influence price developments, with price stability being the ultimate objective, through two channels. First, they have a strong direct impact on currency flows and the exchange rate when capital movements have been liberalized. Second, they affect the interest rates of deposit banks and the entire interest rate spectrum, which in turn influences consumption and investment and thereby affect the level of demand on goods and labour markets. Thus, the Central Bank achieves its objective whether it targets prices directly or indirectly by having the exchange rate as an intermediate target.

First, the international consensus to harmonize standards globally appears fragile. If each country acts to strengthen its financial system in an uncoordinated way, we will be left with a balkanized system, riddled with gaps that encourage regulatory arbitrage. Second, I am concerned that the focus will be too bank-centric. Although it is clearly appropriate to strengthen the liquidity and capital standards for banks, regulatory reform needs to be comprehensive. Third, I worry that the Federal Reserve’s role with respect to bank supervision will be unduly constrained. Let me discuss each of these concerns in more detail. Turning first to the issue of harmonization, I think it is underappreciated how important harmonization is to ensure success of the global regulatory reform effort. Without harmonized standards, financial intermediation would inevitably move toward geographies  BIS Review 28/2010  1  and activities where the standards are more lax. This, in turn, would provoke complaints from those who cannot make such adjustments as easily. The political process, in turn, would be sensitive to such complaints, creating pressure for liberalization, which would cause the tougher standards to unravel over time. In the discussion between countries, the emphasis would subtly shift from how to structure the regulatory regime to ensure financial stability toward negotiating a regulatory regime that works best for the institutions headquartered in each particular country. The harmonization process has some momentum due to the sponsorship of the G-20 leadership and the efforts of the Financial Stability Board (FSB) and other international standard setters.