sunil mendis : financial system stability and basel ii - the way forward inaugural address by the chief guest mr sunil mendis, governor of the central bank of sri lanka, at the 17th anniversary convention of the association of professional bankers, colombo, sri lanka, 28 august 2005. * * * ladies and gentlemen it is an honour for me to be invited to give the keynote address at this forum of eminent bankers in sri lanka and distinguished persons from the international banking arena. i am happy to see our friends from the reserve bank of india and from the basel committee who will no doubt make this convention very lively for discussion on a subject which concerns us all. as central bankers we have a common interest in ensuring financial stability which impacts upon the macroeconomic performance. further, as monetary policy transmission takes place through the financial institutions for the achievement of its target of economic and price stability, the central bank has the responsibility for ensuring that the financial system as a whole is sound. it should be strong enough to withstand internal and external shocks. we must ensure that our payments and settlements system is protected from the risk of failure at any cost since it is the conduit through which our economic business and commercial activity is facilitated. the causes and consequences of the recent asian financial crises are still vivid in our minds and we from our part, as professional bankers, must endeavor to ensure that they are not repeated. the central banks can use both preventive measures and corrective action to maintain financial stability. a constant and continuous monitoring of risks is a preventive measure. crisis resolution is a corrective action. a strong regulatory regime would ensure the former and a financial safety net is an essential component of the latter. the two supplement each other. the cooperation of all parties concerned in both these actions is of paramount importance in maintaining financial system stability. in sri lanka, as in most emerging economies, we have a bank dominated financial system. therefore, ensuring banking soundness will inevitably lead to financial system soundness. the recent initiatives taken in this regard are significant – we have enhanced capital requirements to reflect the increased leverage in the industry. even regulatory capital is at a comfortable margin above the international norm but is still only 10 % of risk assets which is the absolute minimum should these risks materialize. therefore, increasing the minimum capital requirements would provide a healthy platform for growth and expansion of banking business. however, capital is the last line of defence. the more immediate needs are good corporate governance and good risk management which will steer the

not addressed, then problems stemming from structural deficiencies are bound to reappear. concluding remarks in a nutshell, the past global growth model proved unsustainable. the lessons from this and previous crises suggest that failure to address long overdue reform challenges promptly might result in a “ lost decade ” for the global economy. these reform challenges include : achieving a balanced global growth trajectory ; implementing stability - oriented macroeconomic policies ; carrying out structural reforms ; putting in place more flexible exchange rate arrangements ; appropriate financial sector regulation and oversight. only partial progress has been made so far, and the distortions that led to global imbalances are still present. if reform challenges are not met, there is a major risk that global economic activity will remain subdued, high public debt will become more persistent and unemployment will remain high. it is therefore crucial to make headway with our reform agenda, while taking care to ensure that our response to the crisis does not sow the seeds for renewed economic imbalances and financial excesses. thank you for your attention.