effectively than previous deregulation, the creation of the euro has freed a large set of institutional players from foreign exchange constraints on their portfolio choices. it has boosted transparency across the spectrum of financial services, on both product and, equally importantly, cost - of - capital sides, and reduced the informational advantage of institutions vis - a - vis markets. the spectacular growth of the corporate bond market, as part of a broader fixed income market that rivals in size its us counterpart, is probably the most tangible illustration of the resulting transformation. prospectively, it is also one that has the greater potential for altering at its roots the well - established relationships between banks and their clients. in a nutshell, the forces underlying the transformation of the financial industry have vastly heightened competitive pressures, broadening the range of potential service providers well beyond traditional financial firms. experience in the united states indicates that those that can use new communication networks to sell specialised products more effectively ( like consumer credit and mortgages ), or have regular contact with potential customers ( like supermarkets ) can make rapid and significant inroads. as economists would put it, the degree of “ contestability ” in the industry has taken a quantum jump. individual institutions have found themselves squeezed as a result. on the one hand, the tightening in corporate governance mechanisms has gone hand in hand with more demanding profit targets. on the other hand, the changes in the financial environment have made it harder to achieve any given target. for the industry as a whole, deregulation and technological advances have exposed excess capacity in a variety of segments, at both the retail and wholesale level. a look at the performance of the banking industry globally illustrates the forces at work. of course, in the second half of the 1990s, accounting profit measures have tended to be stable or to improve slightly against the backdrop of generally favourable cyclical conditions, with crisis - hit japan being a major exception. from a longer run perspective, however, there has been a widespread narrowing of intermediation margins, a fairly common decline in “ stand alone ” credit ratings and a tendency for bank share prices to lag behind the overall index. interestingly, the united states has been an exception to some of these longer - term trends and, according to some of the above measures, the united kingdom has also outperformed continental europe. i will come back to some of the lessons that might be learned from these different experiences. ii. the fundamental challenges what are the challenges for european market participants and public

more quickly. this will test regulators and supervisors, for whom the challenge will be to create rules of the game that are robust to fad, fashions and arbitrage. there are several consequences of the characteristics i have mentioned and to which will i return. however, one, consolidation, has itself become a characteristic of the present environment. i believe consolidation has much further to run in many countries. so far, it has mainly taken place within national markets, and within particular sectors. looking ahead, however, cross - border and crossfunctional mergers and alliances seem increasingly likely. ii. implications for the authorities as i noted at the outset, a substantive issue raised by the foregoing is how the authorities should respond to the more complex environment that now prevails. in principle, there may be two options : to adjust supervision and regulation to a more challenging environment, or to try and shape the environment so that it is compatible with a more slowly evolving regulatory framework and prudential apparatus. the latter may be possible, within limits, in economies whose financial markets remain relatively heavily regulated and closed off from other markets. but one cannot ignore the difficulty, the costs and risks of deliberately preventing adjustment when the world outside is changing at an ever more rapid pace. a gap that is created – as against one that is being slowly eroded – is one that may later be much more difficult to close. in asia, as elsewhere, countries are following different reform strategies. given the wide range of initial conditions, there can be no single prescription. all the same, two key lessons of the past crises are by now widely recognised. the first is the need to liberalise financial activities and flows in a manner that is consistent with supervisory and infrastructural capacity. firms, supervisors and the infrastructure all need time to adapt to a more demanding and complex market environment. the second lesson is that a comprehensive approach is needed. the financial sector does not exist in a vacuum. its efficiency and stability depend, not only on the prudential standards applied to financial institutions, but on the robustness of the financial infrastructure that underpins transactions. weaknesses in the financial infrastructure can render useless the most careful supervisory oversight. weak accounting and auditing practices are a major source of problems. improved insolvency arrangements are also critical : the absence of fully satisfactory bankruptcy arrangements that permit the orderly restructuring of distressed corporate debt has been an important factor retarding market development, and intensifying financial crises in