Regulation must not stifle markets but seek to make them work better. In the financial sector, this means a judicious mix of rules and incentives for stronger capitalisation, more effective risk management, better transparency, and sharper market discipline. This has been central to the approach taken by the Monetary Authority of Singapore – never hesitating to impose high standards of prudence and financial discipline but always careful to do so in a manner that does not undermine enterprise and innovation. 11. Financial innovation – especially in derivative products – has been blamed as a cause of the crisis. This is not quite correct. Innovation has been a feature of finance for decades. The crisis was caused fundamentally by failures in macroeconomic policies and financial supervision. Monetary policy was too easy for too long in too many countries. This led to low interest rates and lax lending standards that precipitated unsustainable housing booms, mainly in the United States but also in other countries. Financial supervision failed to detect and correct the build-up of leverage in the system, especially in the shadow banking sector. Complex financial products obscured the risks in sub-prime lending and transmitted these risks across the financial sector. As Edwin Truman from the Petersen Institute puts it, “Financial engineering contributed to the market dynamics once the crisis got underway, but it was not ‘the cause’ of the crisis.” 12. Regulation should therefore not restrict financial innovation but seek to create conditions in the market that promote effective risk management.

Regulators used to worry about institutions that were “too big to fail”; now, they worry about institutions that are “too connected to fail”. Size matters ; but connectivity matters more. 21. This high degree of interdependence means that governments in major economies can no longer act in isolation. Regulatory policies must be globally consistent to minimise the risk of arbitrage. Supervisory actions must be internationally coordinated to maximise their effectiveness. 22. Yet, regulation and supervision is essentially a national prerogative, that must cater to the domestic context and circumstances to be effective. Recognising this tension, international policymakers have focused on reaching consensus on international standards that serve as a minimum benchmark, while allowing countries the freedom to choose appropriate regulatory tools to fit individual circumstances. A uniform, one-size-fits-all international regulatory regime will not work. 23. The most striking application of this principle is in the approach being taken for the regulation of global systemically important financial institutions, or G-SIFIs. These institutions, because of their size, complexity, cross-border nature, and interconnectedness, would cause significant disruption to the global financial system and economic activity, if they failed in a disorderly manner. There is thus a need for global supervisory cooperation, in order to identify the key points of failure within such institutions. The Financial Stability Board, together with other international standard setting bodies, is rethinking its approach towards the monitoring, sharing, and mitigation of systemic risks posed by G-SIFIs. BIS central bankers’ speeches  3  24.