mr crockett considers what regulatory consequences should be drawn from the most recent crises in financial markets remarks by the general manager of the bank for international settlements, mr andrew crockett, to the european banking congress in frankfurt / main on 20 / 11 / 98. you have asked me to talk about the regulatory implications of recent crises. before i do so, it is important that we understand the relative roles of regulators and bank management in avoiding excesses and managing risks appropriately. as you all know, the regulatory and supervisory focus has shifted in recent years from quantitative controls and explicit rules to monitoring bank soundness through the quality of internal controls and the banks ’ risk management culture. with this, greater emphasis has been placed on responsibility of bank management and stakeholders, through market discipline, to ensure prudent operations. i think we all agree that bank managers and market participants are better equipped and ‘ incentivised ’ for this task than supervisors. and there is no going back to a world of quantitative controls. at the same time, it is understandable that the ability of banks to repeatedly walk open - eyed into massive overexposure should lead to questions being asked about the wisdom of this change in regulatory and supervisory focus. i will not address this question here. but if the banking and wider financial community is to resist pressures for re - regulation, it is necessary that it should pay much greater heed to the responsibilities for prudent operations that are now more explicitly theirs and theirs alone. what regulatory consequences should be drawn from the most recent crisis in the financial markets? coming to the question you asked, i think it is useful to distinguish between the crisis in emerging markets and the recent heightened volatility in financial markets in advanced economies. even though there are undoubted linkages between them, the regulatory implications to be drawn are rather different. concerning what has happened in emerging markets, there are at least three basic lessons from recent experience. the first is that structural weaknesses in the financial system can be very costly. the second is that there are important feedbacks between macroeconomic instability and problems in the financial sector. and the third is that financial instability can spread contagiously from country to country. the asian crisis began when the overvalued thai baht had to be devalued. the currency crisis then interacted with financial system weaknesses to produce a deep economic recession. and the difficulties in thailand were rapidly propagated across the region and beyond. from this experience

accordingly argued that institutions should be allowed to run down capital in recessions and rebuild it in periods of greater economic buoyancy. whatever the appeal of this argument, however, it ignores the fact that a capital cushion is needed precisely when economic conditions are adverse and confidence is shaky. a policy which appears beneficial to the macroeconomy could then be harmful to the soundness of the financial system and, through this channel, put economic stability in even greater danger. if, therefore, banks ’ capital is to serve its purpose as a cushion in bad times, it follows that banks should hold additional capital reserves when times are good. infrastructure and public goods finally, what could be done to ensure that sufficient public goods are supplied for an efficient functioning of financial markets? governments have generally accepted the responsibility at the domestic level to provide the main elements of the infrastructure which financial markets need. unfortunately, most of these domestic initiatives cannot be simply transposed to the international level. insolvency arrangements may be effective within national boundaries, but remain complicated, even non - existent, when the insolvency involves sovereign states or relates to cross - border claims. supervision remains in the hands of national regulatory authorities, creating difficulties of communication and coordination once financial activity becomes more global. the problem is further compounded by the fact that different types of financial institution are often supervised separately and according to differentiated rules. to a certain extent, the “ core principles ” for effective supervision developed by the various regulatory bodies, address these problems ; however, their implementation still has to proceed much further. safety net provisions promote the stability of the domestic financial system, but are discussed at best in a conceptual or abstract manner at the international level. even in areas which seem more manageable, such as the definition of appropriate accounting standards and valuation principles, international acceptance and uniformity are still a long way from being realised. most of these issues are being addressed in various expert groupings, but the complexities of the issues at hand limit the speed at which progress can be made. * * * if we are to make significant progress in proposing solutions to and correcting the main financial market failures, strategy will be an important consideration. by this i mean, how does the international community go about reaching agreement on how market failures are tackled, then ensuring that the necessary measures are implemented. the first thing to say is this is not an area that lends itself to international treaties. prudent financial behaviour is not something that can easily be reduced