Economic Report President

• seeking to minimize the human cost of financial crises andencouraging the adoption of policies that better protect the mostvulnerable in society• consideration of the elements necessary for the maintenance ofsustainable exchange rate regimes in emerging markets.Each of these steps poses a number of issues and challenges. Manyare interrelated. Some of these issues that the international communitywill be examining in the future are addressed below.STRENGTHENED PRUDENTIAL REGULATION ANDSUPERVISION IN INDUSTRIAL COUNTRIESThe crises of the past year have revealed the importance of strengtheningprudential regulation to promote international financial stability.Global financial integration has led to a proliferation of financial institutionsmaking cross-border transactions, to the growth of offshorefinancial centers and hedge funds, and to the development of a widerange of derivative instruments. In this new environment, investorsmay underestimate the risks they are assuming during periods ofmarket euphoria, and thus contribute to an excessive buildup ofexposures during the upswing.Such developments pose significant challenges to financial regulatorsand supervisors. Regulatory incentives may be needed to encouragecreditors and investors to act with greater discipline, that is, to analyzeand weigh risks and rewards appropriately in their lending and investmentdecisions. Thus, it will be useful to examine the scope for strengthenedprudential regulation and supervision in industrial countries. Herewe explore some aspects of these regulatory challenges.Enhanced International Financial Supervision and SurveillanceTraditionally, supervision and regulation of financial systems havebeen domestically based. But the increased global integration of financialmarkets and the proliferation of institutions doing cross-bordertransactions suggest the desirability of enhanced international financialsupervision and surveillance. Better national and internationalprocedures to monitor and promote stability in the global financialsystem might prove useful.Although good financial supervision still must begin at the domesticlevel, international institutions and national authorities involved inmaintaining financial sector stability must work jointly to foster stabilityand reduce systemic risk. They will also benefit from exchanginginformation more systematically about the risks prevailing in theinternational financial system. A useful contribution in this regardmight be a policy-oriented forum including financial authorities fromthe G-7 countries, key emerging markets, the IFIs, and other relevantinternational organizations.277