Through the events of recent months, we are called upon to learn the lessons from the banks’ limited ability to measure risk and – as a logical consequence – the limited scope afforded to the relevant supervisory authorities. Despite the welcome improvements provided by Basel II, it is naive to assume that weighted capital requirements can guarantee fool-proof bank capitalisation assessments. There is a substantial margin of error which must be taken into consideration. In order to take account of all the variables, a tightening of the traditional requirements in the area of the bank capitalisation, liquidity and indebtedness is necessary. For a financial centre like ours – which includes international banks whose private banking arms generate substantial revenue and consequently rely on having a spotless reputation – such action is vital. BIS Review 50/2008  3  Finally, the banks that have been buffeted by the financial storm must take a careful look at the various ways in which they apply corporate governance. In particular, they should examine the role of their respective boards of directors in carrying out the necessary checks and balances to ensure efficient risk management, and they should correct the excesses of their remuneration systems in a manner that does not put short-term results ahead of the long-term performance. The latter aspect has been the subject of debate for some years already, and now it is time for answers. Impact on monetary policy The turmoil on the financial markets has also had implications with regard to monetary policy.

To achieve this, the strategy to enhance economic and financial resiliency must pay attention to the following considerations: The first is to recognize the benefit of having a well-balanced financial structure. Efficient and well-balanced financial system will allow the system to better manage and absorb shocks as the market would be less prone to one-way market conditions and would posses greater liquidity. A well-balanced financial structure contributes positively to information processing, price discovery, and risk management. The experience of the Asian crisis, for example, points to the critical importance of the development of a long-term local currency debt market, to increase the depth and the breadth of the financial market. In relation to this, the Bank for International Settlements, in their studies, have identified that the lack of diversified structure and market may lead to increased risk from concentration of credit and maturity risks in the banking system as the lack of markets may lead to the mispricing of risk, excessive delay in correcting large exposures, as well as increased vulnerabilities from capital inflows. The second important consideration is the importance of strong financial market infrastructure. One of the key issues for emerging markets is the structural weaknesses which can create disincentive and moral hazard. The presence of such distortions contribute to a build-up of financial vulnerability, hinder growth of market solution for tackling risk, and complicate policy actions in events of crisis management. Progress in correcting these weaknesses in emerging markets, however, may have been somewhat slowed.