randall s kroszner : innovation, information, and regulation in financial markets speech by mr randall s kroszner, member of the board of governors of the us federal reserve system, at the philadelphia fed policy forum, philadelphia, pennsylvania, 30 november 2007. * * * good afternoon. i am pleased to participate in the excellent annual philadelphia federal reserve policy forum to discuss this year ’ s timely topic of innovations in financial markets. innovations in financial markets have created a wide range of investment opportunities that allow capital to be allocated to its most productive uses and risks to be dispersed across a wide range of market participants. yet, as we are now seeing, innovation can also create challenges if market participants face difficulties in valuing a new instrument because they realize that they do not have the information they need or if they are uncertain about the information they do have. in such situations, price discovery and liquidity in the market for those innovative products can become impaired. in my remarks today, i would like to explore the role of information in the development of new financial products and then draw some lessons about risk management and regulation. in particular, i will examine the role that investment in information gathering, processing, and evaluating plays in supporting the price discovery process and how such investment can lead toward a tendency to greater standardization as markets for innovative financial products mature. examples from both history and current experience will help to illustrate this tendency with respect to loan work - outs and restructurings. i will then conclude by considering how a regulatory approach that encourages transparency and sound risk management, such as basel ii, can be valuable in fostering a robust environment for the introduction of innovative financial products. experimentation and learning in new instrument development typically, when a new product is being developed, there is an initial experimentation phase in which market participants learn a great deal about the product ’ s performance and risk characteristics. this phase involves gathering and processing information and modeling the performance of the product in various scenarios and under different market conditions. it may then take time for market participants to understand what, exactly, they need to know to value a product. during the early phases, a fair amount of due diligence is appropriate, given the greater uncertainty associated with innovative products. the investment in gathering, processing, and evaluating information then, as i will discuss, often leads to greater standardization of products and contract terms, which can enhance liquidity of products as their markets mature. in the initial experimentation phase, the terms and characteristics of a new product are

of hierarchy over the last few years. some of them have risen rapidly thru senior positions over a short period of time. while this can bring fresh perspectives on various issues, it is also a fact that given the strategic importance of leadership at the top, it is important to understand the training requirements of top management and fulfil the same. the committee has recommended mentoring programmes for cmd / ceos of banks. i find that cafral has already carved out a niche for itself in this area. 24. we are all aware of the concerns that corporate governance weaknesses in banks world over had contributed to the financial crisis. doubts have been raised on the ability of boards of banks to adequately guide and oversee their institutions. there have been questions on the role of boards of directors and the desired, but frequently missing, skill sets of non - executive directors in light of lessons drawn from the crisis. bank boards are in constant scrutiny of the regulator, shareholders, and various stakeholders. needless to add, directors need to possess adequate skill sets and stay abreast of developments in the financial sector to guide banks and steer them in the right direction. 25. in our country, in terms of the banking regulation act, 1949, not less than fifty - one per cent, of the total number of members of the board of directors of a banking company are required to have special knowledge or practical experience in accountancy, agriculture and rural economy, banking, co - operation, economics, finance, law, small - scale industry or any other matter the special knowledge of, and practical experience in, which would, in the opinion of the reserve bank, be useful to the banking company. there is thus no requirement for a specific educational qualification for nomination as a director. bis central bankers ’ speeches 26. what is interesting is that the committee has deliberated in detail on the issue of compulsory certification of individuals before their appointment as directors on boards of banks. while the committee has recommended that such certification need not be considered as of now, it has thrown open the debate on the knowledge and skill development at the highest decision making body – the boards. formal and systematic induction process and regular training intervention subsequently for members on bank boards have been recommended. these are some of the recommendations, which in my view, can be implemented immediately. certification 27. having discussed the recommendations in broad details, i would like to spend more time on the specific issue of certification in more details. why separate certification is needed? can ’ t the academic