musch, former secretary general of the basle committee. i hope this institute will make an important contribution to disseminating best supervisory practice and supporting the effort to strengthen banking systems. i now turn to the lessons to be learned in the industrial countries from the rather extraordinary episode of market turbulence that began in mid - august. the russian debt moratorium of 17 august sparked a widespread flight to quality, which was followed by a generalised drying - up of liquidity in many markets. this prompted fears that lenders would ‘ disengage ’, leading to a credit crunch. fortunately, markets have more recently gained a certain measure of stability. but we should certainly try to understand what went wrong and how we can avoid such episodes in the future. one problem was that lenders had unrealistic expectations about the extent to which their loans to emerging markets would be protected. it is therefore important that cross - border lending be assessed on a stand - alone basis, and that supervisors make sure that the pricing and management of such exposures are not undertaken on a false basis. in other words, a tightening - up of credit risk procedures is called for. another source of difficulty was that the models used to assess market risk were based too simplistically on established statistical correlations. they did not take adequately into account other types of risk, such as liquidity, volatility and event risk. widely used value - at - risk models caused financial intermediaries to liquidate assets when volatility in asset prices increased. this selling, in turn, caused volatility to increase further and resulted in additional selling. the fact that most market participants used the same basic model led to common reactions, amplifying herd - like behaviour. consideration therefore has to be given to ensuring that common behaviour by market participants does not exacerbate market instability. – 3 – it has to be recognised that all model - based approaches to controlling market risk embody assumptions, explicit or implicit, about market liquidity. the drying - up of liquidity in periods of market turbulence, as market participants seek to disengage from exposure, invalidates a basic premise on which risk management is built. it is therefore all the more important that var - based approaches to risk containment are supplemented by stress - testing. how do you think national governments have fared in implementing bis rules? the scorecard in this connection is not very good. if one looks back at the history of the past 10

mr crockett considers what regulatory consequences should be drawn from the most recent crises in financial markets remarks by the general manager of the bank for international settlements, mr andrew crockett, to the european banking congress in frankfurt / main on 20 / 11 / 98. you have asked me to talk about the regulatory implications of recent crises. before i do so, it is important that we understand the relative roles of regulators and bank management in avoiding excesses and managing risks appropriately. as you all know, the regulatory and supervisory focus has shifted in recent years from quantitative controls and explicit rules to monitoring bank soundness through the quality of internal controls and the banks ’ risk management culture. with this, greater emphasis has been placed on responsibility of bank management and stakeholders, through market discipline, to ensure prudent operations. i think we all agree that bank managers and market participants are better equipped and ‘ incentivised ’ for this task than supervisors. and there is no going back to a world of quantitative controls. at the same time, it is understandable that the ability of banks to repeatedly walk open - eyed into massive overexposure should lead to questions being asked about the wisdom of this change in regulatory and supervisory focus. i will not address this question here. but if the banking and wider financial community is to resist pressures for re - regulation, it is necessary that it should pay much greater heed to the responsibilities for prudent operations that are now more explicitly theirs and theirs alone. what regulatory consequences should be drawn from the most recent crisis in the financial markets? coming to the question you asked, i think it is useful to distinguish between the crisis in emerging markets and the recent heightened volatility in financial markets in advanced economies. even though there are undoubted linkages between them, the regulatory implications to be drawn are rather different. concerning what has happened in emerging markets, there are at least three basic lessons from recent experience. the first is that structural weaknesses in the financial system can be very costly. the second is that there are important feedbacks between macroeconomic instability and problems in the financial sector. and the third is that financial instability can spread contagiously from country to country. the asian crisis began when the overvalued thai baht had to be devalued. the currency crisis then interacted with financial system weaknesses to produce a deep economic recession. and the difficulties in thailand were rapidly propagated across the region and beyond. from this experience