for risk management professionals. and i will offer some perspectives on how these challenges should affect the hierarchy of priorities of central banks, and of those who have responsibility for supervision and oversight of the financial system. a characteristic feature of periods of financial innovation is that growth in new instruments and changes in the structure of those markets can outpace the development of the risk management and processing and settlement infrastructure. this gap, the gap between the speed at which markets move to capture the benefits of new opportunities and the pace of development in the supporting control and execution infrastructure, is inevitable. the size and duration of the gap and the risks it presents to the financial system are a function both of will and of ability. they are determined, in part, by the scale of investments that firms make in the infrastructure - investments in people, in technology and in control processes - and they are determined in part by knowledge and experience, which are functions of the environment surrounding innovation. market discipline exercised by counterparties should create incentives to close these gaps relatively quickly, but competition among financial intermediaries can, at least for some period of time, create offsetting incentives and may make individual institutions less willing to move ahead of the pace of improvement of average practice among market participants. this can take the form of what economists call a collective action problem, leaving individual institutions and the systems as a whole with more risk than would be desirable. and when innovation, such as we are now seeing in credit derivatives, takes place in a period of generally favorable economic and financial conditions, we are necessarily left with more uncertainty about how exposures will evolve and markets will function in less favorable circumstances. the past several years of exceptionally rapid growth in credit derivatives and the larger role played by nonbank financial institutions, including hedge funds, has occurred in a context of very low realized credit losses, low expectations of future default risk, a high degree of confidence in the financial strength of the major banks and investment banks, relatively strong and significantly more stable economic growth, less concern about the level and volatility in future inflation, and low expected volatility in many asset prices. even if a substantial part of these changes prove durable, we know less about how these markets will function in conditions of stress, and the most sophisticated tools available for measuring potential losses have less to offer than they will with the benefit of experience with adversity. several aspects of the present context are worth highlighting. • the scale of the over - the - counter derivatives markets is very large.

other supervisors and identify areas where we can work in parallel to highlight issues we see in the major markets and encourage change among the major institutions. we are in the process, for example, of consulting with these and other authorities on the use of stress testing and scenario analysis in the largest institutions. these efforts of course complement a substantial amount of cooperation in other contexts in the u. s. and internationally in the financial stability forum, the joint forum and the basel committees on banking supervision and payment and settlement systems. these initiatives help keep the supervisors closer to developments in markets, more informed of differences in approaches across the functional and geographic lines of supervision, somewhat more nimble in responding to potential problems and closer to creating a more integrated supervisory framework. the evidence to date suggests that dramatic growth in new instruments for risk transfer and the greater role of nonbank financial institutions have contributed to a more stable and more efficient financial system. but these changes present continuing challenges for the discipline of risk management. and these challenges are likely to continue to require a substantial level of investment by financial institutions to improve the sophistication of the risk management process and the operational infrastructure that supports these markets. thank you. note : i want to thank stefan walter, robard williams, tim clark and beverly hirtle of the staff of the federal reserve bank of new york for assistance and comments.