. it is manifested in the extent of reserve accumulation, in part the consequence of resistance to exchange rate appreciation. and it is manifested in the remaining controls on capital movements and the occasional experimentation with the introduction of new controls. the search for durable insurance against future volatility is an understandable response to the searing experience of the crises of a decade ago. but there is risk in this as well. and the incomplete embrace of integration could contain the seeds of future vulnerability. in this sense, the policy agenda needs to move from a focus on creating stronger defenses against crisis to building a greater ability to adapt to change. this requires strong institutions for the management of macroeconomic policy so that the monetary and fiscal policies are able to respond to shocks in a credible manner. it requires strong financial institutions with a substantial capacity to absorb losses and cope with volatility. it requires regulatory policies that encourage competition and innovation, with strong protections for property rights, low barriers to entry and effective financial supervision. and it requires investments in a nation ’ s human capital, in education, healthcare and pension provision. this complement of policies improves the prospects for producing the mix of flexibility and resilience necessary for sustained growth in a more integrated world economy. in emerging asia, two key areas where there is the need and opportunity for further progress are in the financial system and in the monetary policy framework. the financial sector plays an important role in the flexibility and adaptability of economies to change, in the resilience of economies and in the capacity of the monetary authorities to respond to adverse shocks to asset prices or demand. although much has been achieved in asia over the past decade, as the damage inflicted by the crises has been repaired, further reform will be important to the capacity of these economies to innovate and grow and to live more comfortably with openness to capital flows. this requires stronger banks and more developed capital markets. thus far, we have seen more progress on the former than the latter, but both are important and there remains considerable scope for broadening and deepening capital markets in emerging asia. the extent of financial innovation in the industrial economies makes it possible for asian countries to take advantage of huge improvements in the efficiency of financial intermediation. embrace of these reforms will help ensure that high levels of domestic savings are deployed more efficiently, that companies and financial institutions are able to manage risks more effectively and that the financial system is more resilient in the face of future stress. monetary policy regimes in much of asia

selective liberalization of controls on capital flows and fixed exchange rate regimes. banking systems combined relatively weak supervision with broad government guarantees, some explicit, but more commonly implicit, reflecting a tradition of public sector intervention to protect troubled companies and banks from failure. tax and regulatory incentives promoted short - term borrowing in foreign currency through the banking system. capital inflows, largely through the banking system, helped finance a boom in investment and real estate. distortions in the financial system led to a misallocation of resources so that high rates of private investment did not generate substantial improvements in productivity. exchange rate regimes where the domestic currency was fixed to the dollar generated false expectations of stability, and the resulting increase in unhedged borrowing generated large exposures to changes in the exchange rate or interest rates. by 1997, the short - term external debt of the private sector had risen substantially, relative to gdp and to reserves, and this created conditions similar to a classic bank run, when the crises hit. the initial spark for the loss of confidence is still not fully clear, as is often the case in financial crises. and although the particular dynamics differed across the countries in the region, the basic pattern was common, with a rapid and sustained effort by domestic and foreign investors to reduce their exposure to further losses. the initial effects of this behavior made the exchange rate commitments untenable, and when those commitments were broken and currencies fell, the panic became self - reinforcing. uncertainty and lack of information fed the run. market participants were unable to judge whether deteriorating developments reflected temporary liquidity problems or deeper solvency issues. they reacted by assuming the worst. these shifts in market sentiment risked becoming self - validating, with liquidity problems transformed into solvency problems with broader risk of default. the capacity of policymakers to restore stability was constrained by the depth of the balance sheet problems. in some cases, where the scale of external borrowing was less acute, policymakers had more room to act. but in most cases, policy options were very limited. initially, governments were reluctant to let exchange rates move too far, because of fears that this would force banks and companies that had borrowed in dollars or yen into default on a scale that could further damage growth. at the same time, the authorities were reluctant to tighten monetary policy as a way to help stabilize the exchange rate because of concern it would hurt growth and perhaps exacerbate the flight from domestic assets. this dilemma made the initial policy response in the