so participants in the bond market need to adjust to the current situation rather than simply complain about it. if transaction costs are higher, particularly for transacting in large size, then asset managers and other bond holders need to take account of that in the way they execute their transaction in the market. for example, as discussed above, one solution may be to execute more slowly in smaller parcel sizes. execution certainly needs to be more nimble and considered than in the past. but perhaps more importantly, the increased transaction costs in terms of liquidity and execution should also be taken into account in the way an asset manager constructs its portfolio. the differences in transaction costs across various classes need to be taken into account. if transaction costs are higher, then perhaps i should be transacting less. do i really need to be selling? in some cases, i might not have much choice, because the need to transact may be driven by the mandate i have been given. but in that case, a discussion should at least be had with the provider of the mandate highlighting the higher transaction costs and the implications that has for the portfolio. or maybe i need to transact because of redemption flows out of my fund. in that situation, i may need to think about holding a higher liquidity buffer than i did in the past. if the cost of obtaining liquidity in the market from my bond portfolio is higher than it used to be, then i need to think about weighing that up against the cost of holding more liquidity on my own balance sheet to accomodate potential redemption flows. let me now turn to another concern that is often expressed around bond market liquidity, namely that, with the decline in intermediation by the banks, the likelihood of market dislocation is higher. this often comes up in discussions around the consequences of the fed tightening monetary policy resulting in a large sell - off in bond markets. the “ taper tantrum ” of 2013 is often invoked as an example. this saw a rapid rise in bond yields in a number of emerging markets following indications that the fed was going to wind down its quantitive easing program. as i said last year, i think the issue is not so much one of a decline in liquidity as much as a decline in the capacity to warehouse risk. in the past, when there was a large sell - off in bond markets, liquidity was never that great. a bank has no more desire than any other investor to catch a

ms. phillips discusses recent developments in supervision and regulation and how they affect the debate on financial modernization remarks by ms. susan m. phillips, a member of the board of governors of the us federal reserve system, at the annual washington conference of the institute of international bankers on 3 / 3 / 97. i am pleased to have the opportunity to address this group at a time when developments in global financial markets are presenting particular challenges for market participants and market regulators alike. i was asked to talk with you today about both developments in federal reserve supervision and regulation, as well as the approaches to financial modernization being debated in the congress. i won ’ t try to cover the full waterfront on these topics, but would like to share with you some of the board ’ s considerable rethinking about the way we supervise and regulate bank holding companies. i will also describe how i believe the recent board initiatives coming out of this process may well alter the debate about the structure and supervision of financial services in the united states - - a topic i believe has received insufficient attention in the legislative debate so far. i will focus my discussion of recent board actions on the supervisory process and on three regulatory changes made or proposed by the board : changes to the application and nonbanking provisions of regulation y, changes and proposed changes to the board - imposed “ firewalls ” between a bank and a securities affiliate, and changes to the board ’ s anti - tying rules. i stress these three not necessarily because they are the most important undertaken by the board, but because i believe that they most directly affect the debate about how financial services should be supervised. supervisory changes the cornerstone of the bank supervisory process is the verification of prudent practices and financial condition through on - site examinations, coupled with off - site surveillance. traditionally, on - site examinations of bank holding companies and their nonbank subsidiaries have focused on verifying compliance and determining the financial condition of an institution at the time of the examination by reviewing their loans and by testing other transactions. this process is changing. the federal reserve ’ s supervisory oversight at the bank holding company level is increasingly directed at evaluating risk management, internal controls, and decision making processes that are shared between a bank and its parent, rather than focusing on transactions and positions at nonbank affiliates. this focus is necessary given the continuing trend toward integrated management of financial activities on a consolidated basis. testing the adequacy of risk management and internal control helps us understand the financial condition of the consolidated organization and