Moving forward, the Bank will step up its vigilance of the industry's state of readiness to cope with the changing environment. An orderly transition of the market-led adjustments is vital to ensure that the adjustments does not destabilize the market or undermine public confidence. To this end, efforts will continue to be directed towards building institutional capabilities and putting in place the necessary supporting financial infrastructure to provide a firm foundation for orderly change. Initiatives in the area of financial education for consumers will be intensified to further expand the coverage as well as to promote the fair treatment of consumers. With a strong foundation in place to meet increased competition, further deregulatory and liberalisation measures will be introduced. This will include greater flexibility accorded to foreign insurers to establish branch offices, the progressive deregulation of pricing for tariff-rated insurance products, greater investment management flexibility and removal of limits on management expenses and continuing improvements in disclosure standards to promote greater market discipline in the more deregulated environment. On-going deregulatory measures will also further enhance the ability of insurers to respond more proactively and speedily to changes in consumer demands and market conditions. The prudential framework will also continue to be adjusted to establish principles of sound financial and business practices in the changing environment, with a significantly stronger emphasis on risk-based supervision and effective board and management oversight.

Had the West’s current account deficits been financed by inflows of equity, would the eventual “adjustment” have been less destructive? The flows were, of course, of debt. The accumulated “excess” savings in the East were largely held in official, risk-averse portfolios, notably central bank fx reserves. Their investments concentrated on fixed-income instruments: initially government bonds, but later mortgage and some corporate securities (broadly matching the composition of capital flows into the US, Chart 6). Combined with demographic shifts in the West pushing pension funds into fixed-income, this might have increased global demand for bonds relative to equities, driving down credit and term premia (relative to equity risk premia). For a while there was probably excess – that is to say, unsatisfied – demand for bonds, and that in turn probably had two effects. The generation of new types of supposedly “safe” bonds through securitisation and, in particular, eventually synthetic securitisations.8 Separately, there was arbitrage across asset classes, effected by firms borrowing to buy back their own equity and to acquire others via leveraged buy-outs. In summary, while the ex ante global savings/investment imbalances plausibly drove down equilibrium world risk-free interest-rates, the precise composition of the resulting capital flows will have affected risk premia too. Monetary policy, international banking flows, and global liquidity The other story aired about macro drivers is the possible role of monetary policy and private sector credit creation. And that too points to a role for risk premia.