? the basic need here is for better bank supervision. supervision must be improved to insure that proper risk management techniques are put in place and followed. previous practices where banks, or those to whom banks made loans, loaded up on short - term hard currency denominated liabilities must be curbed. market discipline can also be used to control risk, by exposing financial institutions to as much market discipline as possible and by limiting moral hazard problems. but even with all the preventive medicine in the world, the patient sometimes gets sick, and banks in japan and a number of other countries surely are. what is to be done then? examination of a number of historical episodes suggests that there are three important elements to dealing with a banking collapse. first, the bank regulators must go through the balance sheets, determine the problem loans, take them off the banks ’ balance sheets, sell them, and have the public take whatever losses were entailed. second, the troubled institutions must be closed down with the management replaced and shareholders suffering losses. third, the healthy institutions must then be recapitalized, preferably by new equity sales in capital markets. the sooner these steps are taken, the better. the longer they are not taken, the longer troubled banks will continue incurring losses, engaging in risky practices, threatening the safe institutions, generating contagion effects, and not performing the banks ’ all - important maturity transformation function. indeed, here is a way foreign capital flows can be part of the solution to the problem, because new foreign - owned banks that can perform this maturity transformation function can be invited to participate in credit - starved economies. • maturity transformation. while financial institutions perform maturity transformation, there is no reason to unduly burden the system. countries have often gotten into trouble when they have done too much maturity transformation - that is, borrowed from abroad at short maturities to finance long - term investment. steps could be taken to limit such borrowing, either nationally or through bank supervision. some economists have used this idea to propose taxes on short - term borrowing, though the tax rates necessary to do the job could be very high and it might be more effective to use orthodox principles of bank supervision. • transparency. a further set of corrective mechanisms involves greater transparency. it must be clearer to lenders and borrowers alike what risks they are taking. this requires better reporting by financial institutions, and it also requires better aggregate statistics on the uncommitted foreign reserve balances of

at the same time. as a general rule, the exchange rate flexibility issue is a hard one and it is hard to make broad recommendations. sometimes a country ’ s cost structure is clearly out of line, or its inflation rate is clearly too high, and exchange rate flexibility seems to be the least costly way to bring prices and wages back into line. but exchange rate flexibility will cause capital losses and will raise the cost and risk of future capital transactions. that does not mean that the exchange rate must be preserved at all costs, but it does mean that capital flows themselves put some constraints on the normal international adjustment mechanisms. given all this, it is hard for me to take a firm policy on exchange flexibility, and i have some sympathy for the apparent open - mindedness of the imf on the issue. will these solutions be enough? who knows. but i think we all have a stake in making the world capital system work better. before we initiate more artificial restrictions on capital flows, we should try to improve the system to take advantage of its very large benefits.