Market discipline After effective management at the bank level, the second line of defense against financial instability is market discipline, which is an increasingly important ally of the official supervisor. When armed with timely and meaningful information on banks’ performance, market participants can, by way of their investment and credit decisions, encourage bank managers and boards of directors to manage their risk exposures soundly. Equally as important, market participants can penalize those institutions that do not. But, of course, effective market discipline is not possible without meaningful public disclosure. While significant progress has been made in recent years, it unfortunately remains the case that disclosure practices have not kept pace with the rapid changes in banks’ business activities and risk exposures, and with how these exposures are measured and managed. For this situation to be fully remedied, notions of what is proprietary information and what should be in the public domain must change. Knowing a company’s appetite for risk and its approach to, and methodologies for, managing risk is essential to understanding the risks of being a shareholder, a creditor or a counterparty. All financial market participants should approach the issue of disclosure as users of financial statements rather than as issuers. There should be little question about the urgency of achieving dramatic progress in this area. Clearly, a full appreciation of risk cannot be achieved without sufficient information.

BIS Review 75/2000  2  The difference today is that the timeframe for answering these fundamental questions is dramatically shortened. As supervisors, we must be able to look at rapidly changing financial institutions and assess whether their strategies make sense and whether they are effectively evaluating the risks associated with executing those strategies. Technology and innovation have also rendered geographic boundaries all but meaningless, and undermined the power and control of financial authorities. As you know, one of the principal means of supervising internationally active banks has been the process whereby the host supervisor approves the establishment of a brick-and-mortar presence in its country or jurisdiction. By way of a web-based platform, banks can now target customers far beyond the reach of a typical branch, and even cross borders into countries where they have no local offices and may never have conducted business before. We’ve already seen a few cases in which a bank is chartered in one country, handles its data processing in another, and targets customers in still others. Such situations will surely challenge traditional notions of “home” and “host” supervisor, and raise difficult issues regarding international coordination and cooperation, information sharing, law enforcement and privacy. In a world of instantaneous communication, interconnected markets, and more complex instruments and risks, effective supervision is more important than ever to maintaining financial stability, both locally and globally. To remain effective and relevant, supervisors must understand how and to what extent the “wired” economy and other technologies are changing banking and finance.