##able as the financial system itself – this is the first principle on my list. it is now widely accepted that innovations rarely make the financial system simpler and usually make it more complex. the key financial innovation in the ancient phoenician civilisation was the forward transaction – a financial instrument that every student of financial economics is familiar with today. since then, financial innovations have become increasingly complex – to the point where the instruments used today are often understood by only a handful of experts. but does that mean that we need increasingly complex regulation, too? or could it be that we need only a few simple rules to ensure effective supervision and safeguard financial stability? one current example of this debate concerning simple and complex regulation is the leverage ratio. the advocates of a simple leverage ratio for banks want to replace the current risk - based capital rules with a “ blanket ” capital requirement. they believe that the same percentage of capital should be held against all assets, regardless of their risk. i have to bis central bankers ’ speeches admit that the idea appears appealingly simple at first sight. and it would avoid the mistakes and manipulation that can arise during the complex process of calculating risk weights. yet a leverage ratio would also create the wrong incentives. if banks had to hold the same percentage of capital against all assets, any institution wanting to maximise its profits would probably invest in high - risk assets, as they produce particularly high returns. this would eradicate the corrective influence of capital cover in reducing risk. weighing up the advantages and disadvantages of simple and complex regulation, it is probably better in this instance to use risk weightings in combination with the leverage ratio – which is precisely what the new rules envisage. consequently, the second principle of good regulation is that regulation must be as simple as possible and as complex as necessary. yet sometimes a certain set of circumstances can make regulation needlessly complex. one example of this is again the leverage ratio. the calculation of this ratio, which is essentially quite simple, is complicated by the fact that accounting standards vary from country to country. intricate conversion calculations are needed to make leverage ratios based on us accounting principles comparable to those based on the standards used in europe. if accounting standards were harmonised at a global level, the applicable regulation would be simpler. however, the more complex the regulation, the more important it is to adhere to the third principle on my list : coherence. i believe that regulation must be coherent on at least three levels. first, regulation

. significant downward pressure on the kina contributed towards the upward movements in consumer prices. towards the end of the year, seasonal demand for foreign currency contributed to import price pressure, as retail and wholesale companies accumulated inventories in anticipation of increased domestic demand during the festive season. the 2002 december quarter inflation outcome is expected to be high because of the negative developments of the kina and the increases in the price controlled items. as a result, the annual headline inflation outcome for 2002 is expected to be around 15 percent, significantly higher than the 10 percent outcomes of 2000 and 2001. the annual headline inflation rate for 2003 is expected to be an improvement on 2002, due to positive influences from reduced uncertainties and the tight monetary policy stance taken by the central bank, which is expected to stabilize the financial market. monetary and financial market development because of renewed fears for high inflation, the central bank tightened monetary policy during the second half of 2002. accordingly, the bank increased the kina facility rate ( kfr ) by 2. 0 percentage points in aggregate, from 12. 0 percent in july to 12. 5 percent in august and to 14. 0 percent in november 2002. consistent with the increase in the kfr, market interest rates increased. the level of broad money supply ( m3 * ) increased by 4. 2 percent in 2002, influenced mainly by the growth in net credit to the government. reserve money increased significantly in the last two months of the year, due to maturities of treasury bills by the non - bank private sector. the tight monetary policy stance is expected to be maintained in the first half of 2003, due largely to the following factors : the high underlying inflation rate expected for the december quarter of 2002, and the first half of 2003 ; the prudent implementation of the 2003 budget and uncertainties relating to its external financing ; and the continued recovery of the world economy and its effect on the international prices and demand for papua new guinea ’ s exports. consistent with these assumptions, the central bank will maintain a cautious approach in allowing growth in reserve money. this is due to the underlying high level of liquidity and excess capacity that the commercial banks currently have to increase lending and demand for foreign exchange, which may exert further pressure on the exchange rate. accordingly, the annual percentage change in underlying trimmed mean and headline inflation rates are expected to be 10. 6 and 9. 0 percent in 2003, respectively. thank you for your attention.