3  For example, research carried out at Stanford University greatly enhanced our understanding of the interactions between economic motives, incomplete regulation and market outcomes. And Douglass North, of course, had documented how the development and design of institutions – again, good or bad regulation – has shaped the fortune of countries throughout history. 4  OCC’s Quarterly Report on Bank Derivatives Activities, Third Quarter 2009, US Treasury, Comptroller of the Currency. BIS Review 29/2010  3  Unlike in the case of arbitrage, these price gaps are notional – indeed, speculative – and might be large only because they are not suitably discounted for risk. The state of “meta-stability” of financial markets is one in which large-scale positioning has become a leading force of market dynamics. Indeed, system-wide conditions of overexposure and illiquidity placed the markets in a state of meta-stability, i.e. potentially unstable, ultimately triggering systemic risk. An economy in a state of meta-stability is prone to shocks that are seemingly innocuous but can reveal facts that were either unknown or little appreciated before. This new knowledge can trigger the crisis. 5 Monetary policy in times of crisis And then the crisis came. Immediate action was needed to fend off systemic risk. Governments and central banks around the word were united in purpose. With their actions, central banks broke new ground which monetary theorists will be studying for years to come. The modern theory of central banking had a narrow focus on interest rates.

Not only will banks be expected to improve their external transparency, but they will also be expected to operate more transparently internally. In particular, banks will be expected to ensure that the board of directors and senior management are sufficiently well-informed to be able to meaningfully assess the bank’s risk profile. This will place a premium on effective and accurate risk reporting. Likewise, there is an expectation that senior management will communicate effectively to employees their responsibilities with regard to the effective management of risk. Finally, Basel II will enhance clarity by promoting international co-operation between supervisors. International banking organisations have grown increasingly complex over the years, to the point that in some cases it can be very difficult for supervisors - and even for bank management - to have a clear understanding of their global risk profiles. This highlights the need for effective supervisory co-operation for such organisations. Effectively combining the necessary supervision at the local level in the host country with effective supervision at the consolidated level in the home country requires more thorough exchange of information and better knowledge of financial instruments and links within financial groups. This will heighten supervisory understanding of banks’ activities and will promote consistency in the implementation of standards, a level playing field and the reduction of unnecessary regulatory burdens. Next steps While I have focused my remarks on the new capital framework, I would like to emphasise that corporate governance is much broader than Basel II.