participants responded to the emerging problems and distress. such feedback loops included the siv shutdown and its compounding effects on cdo losses, the asset fire sales driven by risk management response by banks, and heightened concern about counterparty risk that precipitated the hoarding of liquidity. moreover, while these feedback loops were important in setting into motion self - reinforcing losses and deleveraging, it was also the interactions amongst them, through joint exposure to common risk drivers and network linkages, that contributed to the multiplication of losses. let me now turn to the second part of my talk which i will focus on the policy approach to deal with procyclicality. a good starting point to discuss policy is to recognize that business cycles are a normal feature of market economies and their existence – especially the interaction of the three cycles – can not be eliminated. the best we can do is to recognize the cycles and find ways to manage them in a way that markets continue to function without risking systemic instability. reflecting this, it is clear that the objective of policy is to reduce the amplification of the cycles and their interactions by limiting the build - up of excesses. a common wisdom at this time is that policy should aim to limit the build - up of excess in the good time and ensure that the system has adequate capacity or buffers to manage the downturn in the bad time. but because the build - up of financial excess tends to be a result of many factors, some of which are not related to financial institutions, therefore, a broader approach to policy is needed so that many measures, both macro and micro, are used to help solve the problem. apart from being more comprehensive, such approach will help ensure that the economic cost of policy or regulation is spreaded out, thereby avoiding an undue burden falling on a particular sector of the economy or measure. table 1. summarizes the policy framework along the line i have just described. the framework encompasses a three - pronged approach to address procyclicality, focusing on taming the business cycle, the financial cycle, and the risk - taking behaviour cycle through a combined use of macroeconomic policy, financial regulation, and other education and disclosure measures. on macroeconomic policy, especially monetary policy, the role of policy is to achieve longterm economic growth with stability. this means avoiding too - eased monetary conditions for too long by tightening policy when there are signs that risk is being underestimated and

imbalance is developing. for financial regulation, its role is to reduce the procyclical behaviour in the financial institutions by limiting excessive risk - taking. and the role of education and disclosure is to promote greater awareness of risk by making available information to improve risk assessment by market, so that extreme shifts in sentiment and confidence are avoided. important in this context for emerging markets is the abrupt shift in investors ’ confidence that drives sudden reversals of capital flows and liquidity. but amongst all these measures, financial regulation remains the core approach to addressing procyclicality. this is because large and sustained booms on credit and asset prices, once they occur, are typically a reflection of the failure of financial institutions to manage risk. let me now turn specifically to financial regulation. to the extent that financial regulation contributes to procyclicality and excessive risk - taking, supervisors could design their regulation in a counter - cyclical fashion to reduce procyclical behaviour of financial institutions. reflecting this thinking, discussion to date on the role of financial regulation to address procyclicality has focused on four areas. the first is to reduce procyclical tendencies of the basel ii capital regulation by aligning capital requirement more with a longer - term perspective of risk. on this, key measures under discussion include : ( 1 ) building capital buffers by capital conservation measures ; ( 2 ) reducing procyclical effects of minimum capital requirement by adopting through - the - cycle risk parameters to achieve a less pro - cyclical capital ratio ; ( 3 ) promoting forward - looking provision that can cover loan losses that are not yet incurred but expected, with supporting accounting rule and valuation ; and ( 4 ) using additional capital charge for the large and more complex banks based on indicators of systemic relevance. the second area of focus is the use of macroprudential supervision. the aim is to use prudential measures, when needed, to restrain the build - up of risk either in the overall financial markets or in specific asset class. examples here include use of loan - to - value ratio on real estate loans and margin requirements for derivatives and securities transactions. also, a recent idea of using leverage ratio to help take account of the unknown risk beyond those identified by the risk - adjusted capital regulation also falls into this category. the third area of focus is the macro - surveillance of the financial system to monitor aggregate risk and identify structural change that opens up new vulnerabilities by making liquidity and capital regulations