If implemented effectively across the financial industry, stress-testing can help curb destabilizing activities and help prepare financial institutions to deal with macroeconomic or financial shocks. Unfortunately, financial institutions and regulators in emerging economies have lagged behind their counterparts in advanced economies on this issue, especially on the credit and liquidity risk stress-testing. A priority for regulators in emerging economies, therefore, is to move faster on stress-testing. To accomplish this, they should push financial institutions to invest in human resource and technology, with the aim of conducting macro stress-testing at least on an annual basis. As regard implementation, regulators and monetary policy makers must increase coordination  6  BIS Review 98/2008  so that macroeconomic and financial stability assessment can be done in an integrated fashion, so as to arrive at a more relevant and convincing macro stress-testing scenario. Finally, the third challenge or decision is the use of prudential measures. While it is unclear how effective domestic monetary policy can be in checking excessive asset price volatility, the threat of financial instability has given rise to a more prominent role for macro-prudential measures to reduce the procyclicality of the credit market. As we see it, the primary challenge in this respect is how best to move forward. Combining the use of prudential measures with monetary policy is a useful policy option, but it is still an unsettling issue because of the concern for efficiency.

BIS Review 98/2008  7  Market-driven financial market developments need the support of critical infrastructure, namely: (1) Information that allows efficient decision making and pricing on various asset markets, financial as well as related markets such as real estate market, which are still very lacking in many emerging markets, and may be an area of public support. (2) Legal reforms to ensure an enabling environment for innovation in products and business models for the financial system. And (3) Human resource with proper competency in modern financial and risk management are scarce and is becoming a bottleneck for development. The authority may need to step in to facilitate training and accredition of professional standards, if it has external benefits. Notwithstanding these challenges, however, notable progress has been made by emerging markets in the past decade, much of which is catalysed by comprehensive economic reform in which market-oriented economic and financial liberalization have been the main features. For East Asia, despite the progress made, significant gap still exists in diversification, efficiency and robustness when compared to the role played by financial markets in developed economies. Looking ahead, in addition to the pressure from globalization, the shift in demographic structure will also be an additional pressure. This is to say some smaller emerging markets will face an aging population and the increase in demand for wealth management, while the supply of local products are limited for diversification. This will pose challenges for inter-temporal allocation of resource and risk.