This will be increasingly important to the effectiveness of the overall supervisory process, as the SEC moves toward providing a form of consolidated supervision for the largest securities firms. At the international level, we have made considerable progress in developing a network for cooperation and information sharing among national authorities that better matches the increased integration of national financial systems. We have worked to clarify the division of labor among supervisors of institutions with supra-national reach, and to cover gaps in the supervisory overlay. We have also worked to identify and promote the adoption of best practices and standards for many dimensions of the institutional framework that underpins well-functioning financial markets. Strengthening home-host supervisory cooperation and avoiding duplication of supervisory efforts will continue to be top priorities for the international supervisory community, especially as we adopt newer supervisory approaches, such as Basel II. Finally, we need to continue to promote investments in strengthening resilience in critical infrastructure in payments and settlement systems and those institutions that play an important role in market clearance systems. This is a critical part of the supervisory and market oversight process we perform, and there is an active public-private effort underway to bring about further improvements in back-up facilities and overall resilience. The innovations that have transformed finance over the past decade have substantially improved the overall stability and resilience of the U.S. financial system. But these improvements are unlikely to have brought an end to what Charles Kindleberger called “manias and panics” in financial markets.

It is obviously in the interest of institutions that transfer credit risk, interest rate risk, or other risks to understand the performance capabilities of those institutions from which they are purchasing protection. The ability to arrive at informed independent judgments about counterparty risk, however, can be hindered by the gaps that remain in the quality of disclosure. The same developments in financial technology that have improved the sophistication of risk management and the ability to transfer risk can create positive feedback mechanisms that, for at least short periods of time, amplify large moves in asset prices. There have been substantial increases over the past decade in the capacity of the market, meaning the principal dealers, to handle very large increases in hedging-related flows. This dimension of the financial infrastructure is critical to the capacity of our markets to absorb and respond to large shocks. Dynamic hedging of options and other similar strategies, however, depend on the availability of sufficient liquidity to work effectively. Stressful periods, of course, are marked precisely by a material reduction in market liquidity. These changes in the nature of finance have several important implications for the supervisors and those responsible for market oversight. Financial innovation will, in some ways, always move ahead of the evolution in risk management techniques. As supervisors, our challenge is to work to ensure that the sophistication of the supervisory process evolves to keep abreast of the pace of change in financial innovation. This is a formidable challenge, and we need to continue to work hard at it.