set out in basel ii thus aims to ensure that securitisation transactions now have their own economic reality, rather than seeking regulatory arbitrage as was sometimes the case under basel i. based on two fundamental principles – first, the actual nature of risk transfer and second, the significant nature of these transfers – the treatment of securitisation in basel ii applies not only to banks acting as originators and investors but also as sponsors. this treatment also takes account of the many specific mechanisms in this type of transaction, such as early amortisation clauses and credit enhancement. lastly, it introduces a requirement for regulatory capital to be tailored for certain off - balance sheet exposures, particularly liquidity facilities associated with these transactions, which under basel i were generally exempted of any capital charge. second, by reinforcing the link between the capital base and the risks actually incurred, basel ii encourages banks to improve their systems for managing these risks as well as their due diligence procedures. beyond reminding banks of the basic caution required when extending credit, this encouragement is all the more useful in that banks now often play a role in securitisation transactions for which the underlying assets, for example housing loans, may be initiated by unregulated entities, that are not always accountable for their risk analysis and pricing. in other words, the weaker the discipline surrounding the granting of a loan the stronger banks ’ diligence procedures needs to be. thirdly, basel ii gives banks and supervisors a vital tool, pillar 2, with which to assess the risk profile of institutions and in particular to take account of certain risks that are sometimes difficult to quantify but whose impact can be great. by way of example, i shall merely mention refinancing risk and reputational risk. pillar 2 thus enables banks, through the determination of the level of economic capital and supervisors, via for example an increase in capital requirements, to ensure that all of the risks incurred are appropriately covered. fourth, basel ii sets out to promote stress tests as one of the tools for managing and assessing risks. this is very important in dealing with the turmoil like that we are currently experiencing. basel ii stipulates that the stress tests conducted by banks must incorporate the effects of a large increase in credit and market risks as well as those of a rise in liquidity risk. the aim is to ensure that banks hold sufficient capital to absorb severe shocks. fifth and last, basel ii aims to substantially reinforce transparency and market discipline.

basic forex transactions, and the availability of more complex hedging strategies enables producers and investors to achieve their desired risk positions. this owes largely to the ability of modern financial products to unbundle complex risks in ways that enable each counterparty to choose the combination of risks necessary to advance its business strategy, and to eschew those that do not. this process enhances cross - border trade in goods and services, facilitates cross - border portfolio investment strategies, enhances the lower - cost financing of real capital formation on a worldwide basis and, hence, leads to an expansion of international trade and rising standards of living. but achieving those benefits surely will require the maintenance of a stable macroeconomic environment. an environment conducive to stable product prices and to maintaining sustainable economic growth has become a prime responsibility of governments and, of course, central banks. it was not always thus. in the last comparable period of open international trade a century ago the gold standard prevailed. the roles of central banks, where they existed ( remember the united states did not have one ), were then quite different from today. international stabilization was implemented by more or less automatic gold flows from those financial markets where conditions were lax, to those where liquidity was in short supply. to some, myself included, the system appears to have worked rather well. to others, the gold standard was perceived as too rigid or unstable, and in any event the inability to finance discretionary policy, both monetary and fiscal, led first to a further compromise of the gold standard system after world war i, and by the 1930s it had been essentially abandoned. the fiat money systems that emerged have given considerable power and responsibility to central banks to manage the sovereign credit of nations. under a gold standard, money creation was at the limit tied to changes in gold reserves. the discretionary range of monetary policy was relatively narrow. today ’ s central banks have the capability of creating or destroying unlimited supplies of money and credit. clearly, how well we take our responsibilities in this modern world has profound implications for participants in financial markets. we provide the backdrop against which individual market participants make their decisions. as a consequence, it is incumbent upon us to endeavor to produce the same non - inflationary environment as existed a century ago, if we seek maximum sustainable growth. in this regard, doubtless, the most important development that has occurred in recent years has been the shift from an environment of inflationary expectations built into both business planning and financial contracts toward an