of reserves. investors must be confident that banks are establishing sufficient levels of reserves and recognizing loan impairment in a timely fashion. compliance with sound accounting, disclosure, and reserving standards not only protects safety and soundness, but also gives the world ’ s investment community confidence in its analysis of risk exposure from investing in various countries and companies. the absence of such confidence, on the other hand, may lead investors to overreact to adverse financial events in such countries by ceasing investment, immediately withdrawing current investment funds and demanding a high return for any remaining or renegotiated investment in such countries. today ’ s technology and global financial markets enable investors to take these actions very quickly with dramatic consequences, as has recently happened in some asian countries. another issue related to the efficient operation of market forces is that government intervention in the credit and investment decisions of banks distorts market discipline and pricing. such programs frequently cause banks to make less than arm ’ s - length investments in, and loans to, non - economic government - affiliated projects or to individuals associated with such projects. once these loans are made, it is difficult for national supervisors to demand that banks apply prudent reserve and charge - off policies, let alone foreclose on such loans. in addressing governmental interference with market forces at their meeting in london in february, representatives of the g - 7 countries unanimously supported the international monetary fund ’ s requirement that countries receiving imf funds make structural reforms to reduce inappropriate government interference in the market economy. the message that governments should heed is that, ultimately, market forces will come to bear with severe results if firms or nations are artificially protected from market forces. iii. sound capital as a risk - absorbing buffer my third major theme today - - the importance of adequate capital - - has drawn much attention in the past decade as a result of the basle accord. the idea is pretty simple : if we want banks to be prudent in their risk - taking, there is no substitute for requiring banks ’ owners to have their own money at risk. with that requirement, supervisory interests and banks ’ private interests are more closely aligned and banks have fewer incentives to take excessive risks. when banks ’ managers and directors assess the riskiness and profitability of prospective business opportunities, they will weigh heavily the potential effect of new business activities on their banks ’ capital positions. capital must be sufficient, but “ how much capital is enough? ” the answer is linked, of course, to the level

industry by market pressure. this underscores the importance of the overall regulatory and property rights environment to fostering investment necessary for productivity growth in emerging economies. more generally, a related set of policies should focus on strengthening the financial system so that it better channels domestic saving into appropriate domestic investment projects. adopting international best practices in financial supervision and regulation would help promote prudent risk management and effective intermediation. intermediation could also be enhanced by developing capital markets outside the banking system. the creation of secondary markets for mortgage debt and, as i will describe in more detail shortly, the development of local bond markets more generally has promoted deeper and more liquid financial systems in some emerging markets. installing modern trading and electronic payment systems, which facilitate quick and easy allocation of capital, would also help. a simple, intuitive principle governs all efforts to develop markets that channel funds efficiently from a large number investors ( both domestic and foreign ). the principle is that all investors must believe they all have the same access to information about investments and that they all will be treated in the same way. to this end, policies to increase transparency, disclosure, and restrictions on insider advantages are critical ( gelos and wei, 2005 ; ahearne and others, 2004 ). finally, prudent macroeconomic policies – fiscal consolidation and monetary policies aimed at price stability – are crucial to any effort to boost investment and attract financing ( kroszner 2003 and 2006b ). emerging - market financing and the distribution of risks emerging - market economies have, to varying degrees, already made progress in improving their financial environment over the past decade. inflation has been substantially reduced, and fiscal balances have been brought under control. many countries have reformed their financial systems and modernized their business regulations. these policies have helped attract private capital inflows, even though total capital flows still move from developing to industrial economies on net. financing mechanisms in the emerging - market economies have also evolved. most notably, external borrowing increasingly is in the form of bonds denominated in domestic currency, often issued at fixed interest rates, and dated for long maturities, in contrast to the foreign - currency instruments that dominated external borrowing in earlier years. government bonds of this new type were first issued by korea and thailand in the 1990s ; brazil, chile, colombia, indonesia, mexico, and russia soon followed suit ( kroszner, 2006a ). these new instruments have helped establish long - dated benchmark yield curves and thus encourage corporate