in the forex market to prevent appreciation entails costs. if the resultant liquidity is left unsterilized, it fuels inflationary pressures. if the resultant liquidity is sterilized, it puts upward pressure on interest rates which, apart from hurting competitiveness, also encourages further flows. currency appreciation is not the only problem arising from the ultra loose monetary policy of advanced economies. speculative flows on the lookout for quick returns can potentially lead to asset price build up. the assurance of advanced economies to keep interest rates “ exceptionally low ” for “ an extended period ” has also possibly triggered financialization of commodities leading to a paradoxical situation of hardening of commodity prices even as advanced economies continue to face demand recession. emes have been hit by hardened commodity prices through inflationary pressures, and in the case of net commodity importers, also through wider current account deficits. emes have dealt with the problem of excess flows in diverse ways depending on their macroeconomic situation. this has broadly taken one of several forms : controlling capital at entry, taxing it on entry or intervention in the forex market. such measures would have attracted criticism in the past as they went against the broad economic orthodoxy that market forces should not be resisted. the crisis has changed the terms of that debate. it is now broadly accepted that there could be circumstances in which capital controls can be a legitimate component of the policy response to surges in capital flows. managing capital flows should not be treated as an exclusive problem of emes. in as much as lumpy and volatile flows are a spillover from policy choices of advanced economies, the burden of adjustment has to be shared. how this burden has to be measured and shared raises both intellectual and practical policy challenges. our current theory of external sector management draws from an outdated regime of fixed exchange rates and limited capital flows when the task was largely limited to managing the current account of the balance of payments. what we now need is a theory that reflects the changed situation of flexible exchange rates and large and volatile capital flows. the intellectual challenge is to build such a theory that encompasses both current and capital accounts and one that gives a better understanding of what type of capital controls work and in what situations. what is the practical challenge? the practical challenge is that once we have such a theory, we need to reach a shared understanding on two specific aspects : first, to what extent are advanced economies responsible for the cross border spillover impact of their domestic policies, and second, what is

risk management architectures. in this regard, an important lesson thrown up by the crisis is that in addition to managing more effectively the traditional risks such as credit risk, operational risk and market risk, banks also need to manage some new risks that have proven to be significant such as reputation risk, counterparty credit risk, liquidity risk, interest rate risk in the banking book and incremental risks in the trading book. expertise in risk management needs to be complemented by strengthening stress testing techniques. evidently this calls for substantially broadening and sharpening the skill endowment at the institutional level. however, this cannot stop at getting a new toolbox and learning how to use it ; it has to extend to changing the mindset. banks need to develop a culture of risk management at the institutional level. what the crisis has shown is that risk management cannot be done in silos ; it demands a more integrated approach with risks and their interconnections across the entire organization recognized and managed synergistically. 47. buffering the capital base of banks is obviously a standard and much needed response to risk management. in this regard, countries around the world are in the process of migrating to the basel ii capital standard. in its current form, the standard provides a menu of approaches from simple to advanced to assess credit, market and operational risks and to calibrate the capital requirement to the assessed risk. importantly, the standard provides a framework for assessing the new risks that i talked about earlier. 48. india is committed to adopting the international best practices though with the sequencing and pacing determined by our domestic conditions. as of march 2009, all indian banks have migrated to the simpler approaches of the basel ii standard. the task on the way forward is to graduate to more advanced approaches. towards this end, in consultation with banks, the reserve bank has now finalized a four - year time frame starting in april 2010 and ending with march 2014. moving to advanced approaches is both skill and technology intensive. in the first instance, it will therefore necessarily have to be confined to the larger banks. while the reserve bank will actively facilitate the transition of such larger banks to advanced approaches, it is expected that the banks themselves will be proactive in preparing themselves to meet the preconditions for the transition in view of the competitive advantages it will offer. 49. all in all, going forward, risk management is going to involve pushing the frontiers of knowledge and transforming that knowledge to practical policy. that can hardly fit the description