foreign exchange transactions are bilaterally negotiated, they are cleared and settled through ccil. today cdss prices / spreads are by far the most closely monitored early warning signals for real time changes in credit risk of an entity whether private or sovereign. this is because cdss make it possible to back out an implied credit price even when one is not discovered in the underlying cash market instruments like bonds or loans. thus, cds market has tremendous practical application as a reliable diagnostic tool in stress - testing for supervisors and regulators. besides, a cds market will also enable efficient hedging and trading of credit risk and synergise development of active and liquid corporate bond and repo markets. like equity, credit risk subsumes all other risks as it is a function of forex risk, interest rate risk, leverage risk, liquidity risk, governance risk and that is why cdss and equity prices are, in equilibrium, almost perfectly negatively correlated. as is invariably the case with any major crisis, the ongoing global financial crisis has unleashed a passionate debate over the design of a new global financial architecture. the opinion on overarching role in global financial surveillance is sharply divided between assigning it to financial stability forum, on the one hand, and to imf, on the other. however, the trouble has been not so much with the existing, inter - temporally evolved, global financial architecture as really with how it was actually worked in practice. recent huge losses at global banks running to about usd 1 trillion are not because existing best practices failed but because those responsible for implementing and enforcing them failed them! after all, of all risks to regulators and regulatees alike, human resources risk is by far the most serious as it is the source of all risks as confirmed by the ongoing financial cataclysm. the crux of the matter is what we need is not more or less regulation and governance but good regulation and governance. this has been the undoing of both regulators / supervisors and financial firms / banks alike. in the way of example, in the usa, the traditionally very healthy aaa rated mono - line bond insurers mbia and ambac changed their business model from insuring only their staple municipal bonds to insuring cdos and abs. while this went unnoticed by insurance regulators, pershing square, a hedge fund, spotted trouble and started shorting both equity and credit risk of these two companies. but even after this, regulators failed to take notice and corrective action with the

v k sharma : genesis, diagnosis and prognosis of the current global financial crisis address by shri v k sharma, executive director of the reserve bank of india, at the senior management conference, mumbai, 21 november 2008. the views expressed are those of the author and not of the institution with which he is associated. * * * i heartily welcome you all to the senior management conference 2008. as at the time of the last senior management conference, the now 14 - month old, and still ongoing, global financial market convulsion, with no hint even now of its cataclysmic denouement, and its recent direct outcome, the widespread global economic slowdown, provide, again, the perfect backdrop, and contextual topicality, to this year's conference theme " financial sector development in india : agenda for rbi in the next 5 years ". while in my address last year, i had identified broad spectrum and generic failure of an inertial regulatory and supervisory system as being the genesis of the crisis, this year, i propose to briefly review its evolution since, and make a modest attempt at the prognosis of, and lessons from, the crisis. as we are aware, since the onset of the global financial crisis, the worst since the great depression, the typical stock policy response has been to dramatically and aggressively cut interest rates and inject ever increasing doses of liquidity, giving the impression that the crisis was diagnosed to be liquidity - genic when, in fact, it was fundamentally, asset toxicity - genic. the latest data indicate that the fed, ecb, the bank of england, the bank of japan and swiss national bank have together injected usd 2. 74 trillion in outstanding amount of liquidity. it may not be entirely fortuitous / coincidental that the estimates of total potential write - downs and losses which range from usd 1. 5 to 2. 5 trillion also roughly match the amount of central bank liquidity outstanding! in this context, the popular refrain that banks are continuing to “ hoard ” liquidity borrowed from central banks, and which is why 3 month libor – ois spreads continue to remain elevated, is a myth for no bank will ever countenance a negative spread which will do no more than burn a bigger hole in its capital / balance sheet. perhaps, the logical reason for this is that even after having written down a whopping usd 965 bn. of assets, and having raised usd