of the imf ’ s surveillance work. in institutional terms this change in focus is highlighted by the creation of a new capital markets division in the fund, which prepares a regular global financial stability report. that document, which has attracted too little international attention so far, is a brave attempt by the fund ’ s staff, reinforced by new recruits from the financial markets under gerd hausler, late of dresdner bank, to focus attention on potential sources of financial instability in institutions and markets. that means, at times, drawing attention to weaknesses in the banking and insurance systems even of g7 countries, which has hitherto been difficult territory for the imf. yet it is important for it to do so, not wholly because of the potential benefit for g7 countries themselves, but also to show that developed countries are taking the medicine which they now impose on others. this is because the second major change at the imf has been the rapid expansion of its work on financial regulation. the fund is now committed to preparing financial sector assessments ( fsaps ) of member countries, and indeed of some non - members too, such as the significant offshore financial centres. these assessments review the effectiveness of regulatory structures, financial regulation and adherence to internationally accepted financial sector core standards and codes. what is the rationale for this activity, which is now consuming a significant proportion of the fund ’ s resources? the asian crisis demonstrated that poorly regulated financial systems, particularly banking systems, could themselves be a cause of crisis, even where the macro - economic position might look relatively stable. in the case of countries like indonesia, korea and thailand it became clear after the event that their banks were heavily exposed to currency risk through unhedged dollar borrowings. furthermore, that the regulators in those countries had paid little attention to this mismatch, and indeed little attention to credit quality. in many cases banks were far too close to the companies to which they lent. there had been a rapid expansion of connected lending and little policing of large exposures, so banks were highly vulnerable to individual corporate collapses. that, in turn, precipitated the crisis in the banking system which turned an economic adjustment into a full blown systemic collapse. certainly, it will take some time for this imf assessment programme to bear fruit and it will be crucial to turn initial assessments into effective long - term mitigation and implementation strategies. this will require both political commitment and, where appropriate, technical assistance. but there are signs

. this has been the subject of some entertaining exchanges between warren buffett and alan greenspan, in the last couple of weeks. to simplify grotesquely, warren buffett believes that credit derivatives have generated new risks for the financial system ; alan greenspan believes they are one reason why there has not been more financial instability during a period when markets have been highly volatile. this is a difficult debate in which to take sides. my own view is that neither proposition is rigorously proven at this stage. so my cautious recommendation as a regulator is that we need to know more about how these derivatives are used, and where credit risk has ended up as a result. in particular, we need to know whether regulatory arbitrage is one of the causes – whether risk is migrating to sectors with inadequate capital requirements for this type of risk. that is a subject on which many fsf members agree that our knowledge base is inadequate. so far the international regulatory community has not been successful in getting a grip on the extent of the possible systemic problem. it is a gap which needs to be filled quickly. similarly, i am not sure we know enough about the hedge fund market. i chaired a working group on highly - leveraged institutions for the financial stability forum, which reported a couple of years ago. our conclusion then was that there needed to be better risk management by hedge fund counterparties, better risk management by highly - leveraged institutions themselves, enhanced public disclosure by those institutions, and some other related changes. i am not one of those who believes that hedge funds are inherently dangerous beasts in the financial jungle. indeed in many cases hedge funds have been useful in being prepared to take positions, sometimes counter - cyclical positions, which have helped stabilise markets. but the sector has grown dramatically, and as the long - term capital management problem showed, if leverage is uncontrolled, even one fund alone can be a destabilising factor. so while i do not believe that the case for direct regulation of hedge funds is made out, i do think we need more transparency, particularly about the extent of their leverage, and the recommendations to that effect in my earlier report have not been effectively implemented as yet. it is encouraging that under its new chairman the sec are holding a series of roundtables on the subject in new york. lastly, in this very brief review, i would identify significant gaps in the consolidated supervision of some large and diversified financial groups. banking supervisors have learned from bitter experience