. c. stein ( 2004 ), “ cyclical implication of the basel ii capital standards, ” economic perspectives, 1q / 2004, federal reserve bank of chicago. rajan, r. g. ( 2009 ), “ cycle - proof regulation, ” the economist, april 8, 2009. " contingent " regulations have the following properties. during the up - phase period, they should mitigate overconfidence to prevent the accumulation of systemic risks once systemic risk actually emerges, however, they should impose few restrictions to avoid reinforcing economic deterioration. in preparation for a severe erosion of confidence, they may be furnished with some policy incentives to restore confidence. to sum up, it is desirable that regulations be contingent on risk - taking attitudes of market participants, and thus strict during booms and loose during busts. " cost - effective " regulation is a concept which is important in the evaluation of regulations. this standard dictates that when one or more regulations could achieve the same results, the least expensive approach should be chosen. for example, if it is desirable to induce financial institutions to raise capital, it is better to do so during boom times when funding is readily available as opposed to slump times when the economy has begun to turn sour and the funding cost is higher. this standard is also important when considering how to use public funding. when making the decision between injecting capital and purchasing nonperforming credits, one must consider costs involved as well as benefits of policy effects. currently, the basel committee on banking supervision and many other fora, interest groups and ad hoc groups are floating many different proposals about how best to regulate finance. taking the " 3 cs " in mind, i would like to take up several regulatory reform proposals that have come out of the international debate and examine their significance. in doing so, it is perhaps easiest to divide regulations into two categories : " ex ante measures " to be taken to prevent the crisis and " ex post measures " to influence how the crisis plays out when it happens. these could also be termed " policies for normal times " and " policies for emergency times. " ex ante measures the basel committee on banking supervision is taking the lead in a discussion on ways to alleviate the procyclicality of capital adequacy requirements. as i explained, current capital adequacy requirements are considered to have procyclicality properties. in response, the discussions focus on the idea of introducing variable " buffer capital

drying up quickly in the interbank market. the event has come to be known as the " paribas shock. " many european banks were among those facing liquidity difficulties. confronted with this situation, the european central bank ( ecb ) promptly announced that it was prepared to supply massive amounts of liquidity into the short - term money market. 5 in point of fact, mmfs played a role in deepening the crisis during the " lehman shock " of september 2008 as well, as will be discussed below. the reserve primary fund, a major independent mmf, held large amounts of cp issued by lehman brothers. the fund incurred large losses because of the bankruptcy, plunging it into some argue that there may be an excessive maturity mismatch on financial institutions ’ balance sheets as a background factor that triggered the liquidity crisis. certainly, a close observation of the facts in the current financial crisis exposes not only the maturity mismatch but also the " liquidity uncertainty " that is the fundamental risk inherent in all financial instruments. it is a truism that liquidity is largely unrecognized while it exists and only understood once it disappears. for example, the design of abcps assumes that they can be sold on the market at any time if necessary, but when crisis actually occurred, these instruments could not immediately be sold. had institutional fund - raising been a little more long - term, there would have been a time cushion that might have enabled them to deal with the crisis in liquidity. although it may not be possible to take every possibility into account in the selection of assets, a constant awareness of the uncertainty of liquidity and continuous assessment of the maturity gaps between assets and liabilities are key factors in improving the soundness of financial institutions. one often - heard opinion is that credit default swaps ( cds ) and other financial derivatives amplified the instability of the financial markets in the current financial crisis. opinions will differ on the merits of cdss themselves, but no one would deny that the dysfunction of the over - the - counter ( otc ) market, where these instruments were primarily traded, undermined confidence in financial markets as a whole. on september 15, 2008, lehman brothers declared bankruptcy. right around the same time, the market began to talk about american international group, inc. ( aig ) being on the rocks as well, and its share price plummeted. aig sold large volumes of cds protection, in which it was believed that there