expected ; so when an implosion happens, it can be disastrous, even catastrophic. 10. second, uniquely financial firms are highly leveraged and interconnected. if a non - financial firm fails, only the stakeholders in that firm bear the damage ; the externalities are limited. in contrast, financial firms are all interconnected ; any pressure in one institution or one market rapidly transmits to the entire financial sector gathering momentum as the contagion spreads. the most vivid demonstration of this is the way a bubble in the us sub - prime housing market snowballed into the biggest financial crisis of our generation. 11. third, a defining characteristic of financial markets is their procyclicality ; financial firms exhibit a strong collective tendency to overexpose themselves to the same type of risk during an upturn, and become overly risk averse during a downturn. this is, of course, the familiar fallacy of composition. a particular business model may be profitable for a given bank ; but if all banks follow the same business model, the build - up of procyclical risk can make the model collectively disastrous. in other words, a collection of healthy financial institutions does not necessarily make a healthy financial system. 12. finally, financial markets are different because they are reflexive in the sense that our beliefs about what may happen often influence what does happen. as the economist magazine asked some time ago, is a hurricane more likely to hit because more hurricane insurance has been written. common sense says no. but in the financial world, that common sense does not hold. the more financial insurance is written, the more likely that the insured event will occur because people who benefit from the contingency can make it happen. 13. i have gone at length on these arguments to emphasize that financial markets are different from other markets in some fundamental ways warranting a different approach to innovation and regulation. bis central bankers ’ speeches what do these differences imply for responsible innovation and regulation in the financial sector? 14. that takes me to my second question : what do these differences that distinguish the financial sector mean for responsible innovation and regulation? let me try and address that. 15. one of the fundamental assumptions of economics is that human beings are rational. this concept of a “ rational human being ” provides the intellectual foundation for the libertarian philosophy of political economy which believes that it is unnecessary, even improper, to protect people against their choices. rational people should be free, and they should be responsible for

obligations to current and prospective borrowers is that they remain profitable and solvent. it is in this context that following regulatory actions have been launched in recent past which are a fair mix of both, prudent regulation and right incentives to support growth with proper risk management : • guidelines on “ early recognition of financial distress, prompt steps for resolution and fair recovery for lenders : framework for revitalizing distressed assets in the economy covering formation of joint lenders ’ forum ( jlf ), corrective action plan ( cap ), “ refinancing of project loans ”, “ sale of npas by banks ” to facilitate early recognition / resolution of financial distress • banks permitted to grant an extended debt repayment period to their borrowers in long - gestation projects ( “ 5 / 25 ” scheme ) • enabled banks to take steps for strategic debt conversion ( sdr ) giving them right to convert their outstanding loans into a majority equity stake if the borrower fails to meet conditions stipulated under the restructuring package • enhanced fraud monitoring framework • issuance of long term infrastructure bonds to facilitate financing of long term infra projects • revoking forbearance on restructuring certain other regulatory measures like revision of the single / group borrower exposure limits and identification of d - sibs, etc. have also been initiated. role of the auditor community in promoting sustainable growth 18. let me now turn to some messages that i would like to give the auditor community present here. first of all let me compliment you for the very critical role that you play in keeping the banking sector healthy by auditing the balance sheets of banks and that of the borrowers to whom the banks lend. i would, however, begin on a light - hearted note. i quote former aig vice chairman jacob frenkel, who, in the aftermath of the financial crisis, once bis central bankers ’ speeches quipped, “ the left side of the balance sheet has nothing right and the right side of the balance sheet has nothing left. but they are equal to each other. so accounting - wise, we are fine. ” i am sure we don ’ t want our accounting system to be fine like this. 19. external auditors play a vital role in maintaining market confidence in audited financial statements. in the case of the banking industry, this role is particularly relevant to financial stability given banks ’ financial intermediation function within the economy as a whole. core principle 27 of the basel committee ’ s core principles for effective banking