the rise in optimism leads to increased risk - taking, resulting in increased demand for credit and rise in asset prices. in this period of optimism, the pricing of risk tends to fall, lending spread narrows, and banks tend to provision less as they focus more on a short - term outlook rather than a longer - term perspective of risk. this leads to an upswing in the financial cycle. demand for credit is further bolstered by a rise in asset price which raises the valuation of collactoral, further raising confidence and magnifying the risk - taking behaviour and leverage. next, greater availability of credit leads to more spending and adds to the expansionary forces as business outlook is elevated by perception of low risk and strong profitability. it is when confidence changes that the interactions of the three cycles go into reverse. decline in confidence closes down the risk - taking behaviour, leading to a fall in credit demand. banks respond to this re - assessment of risk by de - risking their financial exposure, exacerbating the downturn in the financial cycle. this results in large adverse impacts on the real economy that further weaken confidence. in the downturn, the three cycles interact and move in synchronization, propagated by deteriorations in the balance sheets. it is only when confidence improves, typically following a major policy intervention, that the downturn both in the business and financial cycles begin to stabilize. with reference to the current crisis, there were at least two specific features of the financial structures in the advanced economies that amplified the procyclical tendencies in the three cycles i have just described, thereby making the situations worse than might have been. first, the duration of the upswing in the financial cycle was made longer by changes in the financial structures that resulted from financial innovation, misplaced incentives, and the way businesses had expanded by circumventing financial regulation which allowed risk to be underrecognized for a long period. a case in point is the originate - to - distribute model, the cdo derivatives, and the use of sivs as a vehicle for taking risk out of banks ’ balance sheets. second, in this crisis the downturn of the cycles were particularly damaging partly because of the interactions or feedbacks within the financial system, as opposed to the interactions between the financial system and the real economy. these within - the - system interactions took the form of positive feedback loops in various market segments that were set in motion in the downturn as market

, some have become state - owned via rescue programme. their systemic importance has risen further along with their market power, and regulation must rise up to the challenge. the interdependence of the financial sustainability of these financial giants and sovereign risks have become increasingly linked, while perception of state guaranty of such institutions may distort local or even global markets, creating un - level playing - field. the demand for accountability for public bail - out money puts pressure on managing such banks, which have now become “ public institutions ”. thus, the intervening authorities face a strong risk of having to micro - manage the institutions, and with this the associated risks, not least reputational and legal. timely exit is important for the reason cited. exit policy however could also be complicated, for example if recovery value of bailed - out fund is under pressure from weak market conditions. most importantly, it is important to observe that, the precedence set by the actions regulators took in such intervention could have a long - term implication. we may very well be setting a new expectation, standard and text - book for bank resolution, and it may not be the standard we want to set going forward. moral hazard and time inconsistency are always difficult subjects. for financial institutions in the seanza region, many regional financial institutions, thus far unaffected directly by the crisis, are also moving into new markets, such as expanding regionally. indeed, there is some indication of search for yield, as managed funds start to flow overseas to markets which have attractive risk - return prospects, for example due to prospect of faster recovery, or due to some distortion created from implicit risk - guaranty on certain asset classes as a consequence of rescue package. in some countries, certain asset classes such as real estate may be benefiting from ample liquidity, giving rise to concern on asset bubble. all these spell potential for increased volatility and demand increased vigilance on management of risks, not only for those arising from country risk and market risk exposures, but also to exposures from counterparty and liquidity risks arising, for example, from hedging positions in otc markets. some of these risks, such as country risk, may have hitherto been marginal for regulators in emerging markets, but going forward things may change quickly. moreover, with credit - play still a very risky and expensive business, with lending subdued by low demand for loans, treasury return could be a potential profit centre, especially