Risk Management Presentation August 6 2012

7/28/2019 Risk Management Presentation August 6 2012

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International Association of Risk and ComplianceProfessionals (IARCP)

1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750www.risk-compliance-association.com

Top 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped the week's

agenda, and what is next

George LekatisPresident of the IARCP

Dear Member,

The Euro is like a bumblebee( a member of the bee genus Bombus, in the family Apidae).

What? Who said that?

According to Mr Mario Draghi, President of the European Central Bank,at the Global Investment Conference in London:

And the first thing that came to mind was something that people saidmany years ago and then stopped saying it: The euro is like a bumblebee.

This is a mystery of nature because it shouldnt fly but instead it does.So the euro was a bumblebee that flew very well for several years.

International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
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And now and I think people askhow come? probably there wassomething in the atmosphere, in the air, that made the bumblebee fly.

Now something must have changed in the air, and we know what afterthe financial crisis.

The bumblebee would have to graduate to a real bee. And thatswhat itsdoing.

The first message I would like to send, is that the euro is much, muchstronger, the euro area is much, much stronger than people acknowledgetoday.

Ok. I have to learn more about the bumblebee. I could add it to the Basel

iii class (something like from the Market Risk under Basel 2 to theBumblebee Market Risk under Basel 3 )

Bumblebees are social insects that are characterised by black and yellowbody hairs, often in bands.

Like their relatives the honey bees, bumblebees feed on nectar and gatherpollen to feed their young (bees have not discovered bonuses yet).

Read more (about what Mr Mario Draghi said, not about bumblebees) at

Number 10 of our list.

Welcome to the Top 10 list.

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NIST Updates Guidance on NetworkAttacks and Malware

Detecting and stopping malicious attackson computer networks is a central focus ofcomputer security these days.

The National Institute of Standards and Technology (NIST) is asking forcomments on two updated guides on malicious computer attacks: one onpreventing, detecting, and responding to attacks and one on preventingand mitigating the effects of malware, a potent tool in an attacker'sarsenal.

Glenn Stevens: The lucky country

Address by Mr Glenn Stevens, Governor of the ReserveBank of Australia, to The Anika Foundation Luncheon, supported byAustralian Business Economists and Macquarie Bank, Sydney.

Kiyohiko G Nishimura: Inter-regional financialcooperation another layer of financial cooperationtowards financial stability

Remarks by Mr Kiyohiko G Nishimura, DeputyGovernor of the Bank of Japan, at CEMLAs 60th

Anniversary Commemorative ConferenceCentralBank Cooperation at the Beginning of the 21stCentury,Mexico City.



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Register of Insurance Undertakings

The compilation of registered financial institutionspublished herein is intended to provide easily accessible information inaccordance to Article 8 of E IOPA Regulation.

Isle of Man FinancialSupervision Commission

Finance sector profits riseoverall, despite challengingtimes

The Financial SupervisionCommission has published itsAnnual Report for 2011/ 12.

DEPARTMENT OFLABOROccupational Safety and Health Administration

Procedures for the Handling of Retaliation ComplaintsUnder the Employee Protection Provision of theSurface Transportation Assistance Act of 1982 (STAA),as Amended

ACTION: Final rule.



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The threat of illegal exports from the FBIs perspective

Robert S. Mueller, II I Director, Federal Bureau of InvestigationU.S. Department of Commerce, Bureau of Industryand Security Annual Update Conference on ExportControls and Policy, Washington, D.C.

DARPA Makes 10 Million Strides in the Race to

Contain a hypothetical Pandemic

FASB Issues AccountingStandards Update to Simplify Testing of Indefinite-Lived IntangibleAssets For Impairment

The Financial Accounting Standards Board (FASB) has issued

Accounting Standards Update No. 2012-02, IntangiblesGoodwill andOther (Topic 350): Testing Indefinite-Lived Intangible Assets forImpairment.

Mario Draghi: Verbatim of the remarks at theGlobal I nvestment

Speech by Mr Mario Draghi, President of the

European Central Bank, at the Global Investment Conference, London



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NUMBER 1

NIST Updates Guidance on Network Attacks and Malware

Detecting and stopping malicious attacks on computer networks is acentral focus of computer security these days.

The National Institute of Standards and Technology (NIST) is asking forcomments on two updated guides on malicious computer attacks: one onpreventing, detecting, and responding to attacks and one on preventingand mitigating the effects of malware, a potent tool in an attacker'sarsenal.

The publications are being revised to reflect the changes in threats andincidents.

Malware, also known as malicious code, is a common tool that attackersuse to breach computer networks today, causing damage and disruption,and often requiring extensive recovery efforts.

"Malware threats in the past tended to spread quickly and were easy todiscover," explains co-author Karen Scarfone, "but today's malwarethreats are stealthier, specifically designed to quietly, slowly spread,gathering information over extended time frames and eventually leadingto loss of sensitive data and other problems."

The updated Guide to Intrusion Detection and Prevention Systemsdescribes software that has become a necessary addition to the securityinfrastructure of many organizations.

Intrusion detection and prevention systems (IDPSs) record informationabout observed security-related events, notify security administrators ofthe events that should be analyzed further and produce reports forevaluation. Many IDPSs respond to and try to stop detected threats byusing a variety of techniques.



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The guidance describes the characteristics of IDPS technologies andprovides recommendations for designing, implementing, configuring,securing, monitoring and maintaining them.

The publication discusses four types of IDPS technologies:

network-based, wireless, network behavior analysis and host-based.

"IDPS for wireless is an important type for all organizations to havebecause of the growth of mobile devices and employees' desire to usetheir own wireless device for work," says Scarfone.

While many agencies and companies are going mobile, it is still critical toprotect desktops and laptops.

The Guide to Malware Incident Prevention and Handling for Desktopsand Laptops is a supplement to another draft document, Computer

Security Incident Handling Guide (SP 800-61).

It gives background information on the major categories of malware thatafflict desktop and laptop computers and provides practical guidance onhow to prevent malware incidents and on what to do when a system isinfected.

The revised version of SP 800-61 is expected to be published later thissummer.

Recommended measures include developing prevention plans based onthe attacks that are most likely to be used now and in the near future,using defensive architecture methods to reduce the impact of malwareincidents, and including malware incident prevention in employeeawareness and training programs.

The Guide to Intrusion Detection and Prevention Systems (SpecialPublication 800-94, Rev. 1) can be found at:http:/ / csrc.nist.gov/ publications/drafts/ 800-94-rev1/draft_sp800-94-rev1.pdf

The Guide to Malware Incident Prevention and Handling for Desktopsand Laptops (Special Publications 800-83, Rev. 1) can be found at:http:/ / csrc.nist.gov/ publications/drafts/ 800-83-rev1/draft_sp800-83-rev1.pdf

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Note

Intrusion detection is the process of monitoring the events occurring in acomputer system or network and analyzing them for signs of possibleincidents, which are violations or imminent threats of violation of

computer security policies, acceptable use policies, or standard securitypractices.

Incidents have many causes, such as malware (e.g., worms, viruses),attackers gaining unauthorized access to systems from the Internet, andauthorized users of systems who misuse their privileges or attempt to gainadditional privileges for which they are not authorized.

Although many incidents are malicious in nature, many others are not; forexample, a person might mistype the address of a computer and

accidentally attempt to connect to a different system withoutauthorization.

An intrusion detection system (IDS) is software that automates theintrusion detection process.

An intrusion prevention system (IPS) is software that has all thecapabilities of an intrusion detection system and can also attempt to stoppossible incidents.



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Note:



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About NIST - National Institute of Standards and Technology

Founded in 1901 and now part of the U.S. Department of Commerce,NIST is one of the nation's oldest physical science laboratories.

Congress established the agency to remove a major handicap to U.S.industrial competitiveness at the timea second-rate measurementinfrastructure that lagged behind the capabilities of England, Germany,and other economic rivals.

Today, NIST measurements support the smallest of technologiesnanoscale devices so tiny that tens of thousands can fit on the end of asingle human hairto the largest and most complex of human-madecreations, from earthquake-resistant skyscrapers to wide-body jetliners toglobal communication networks.

NUMBER 2



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Glenn Stevens: The lucky country

Address by Mr Glenn Stevens, Governor of the ReserveBank of Australia, to The Anika Foundation Luncheon,supported by Australian Business Economists andMacquarie Bank, Sydney.

Thank you for coming today to support the Anika Foundation.

Before I proceed I want also to thank Macquarie Bank for their support,once again, in providing todaysvenue and sustenance, and theAustralian Business Economists for their continuing organisationalsupport for these annual functions.

It is slowly becoming better recognised that the Australian economysrelative performance, against a very turbulent international background,has been remarkably good.

Many foreign visitors to Australia comment on this relative success and I

have noticed an increase in the number of foreign companies interested ininvesting in Australia as a result, notwithstanding our domestic tendencytowards the glass half empty view.

But some observers admittedly not the majoritystill harbour concernsabout the foundations of recent economic performance and question thebasis for confidence about the future.

There are several themes to these doubts, but the common element is that

recent relative success owes a certain amount to things that will notcontinue to luck and that our luck may be about to turn.



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Rapid growth in Chinese demand for resources, for example, has been ofgreat benefit to date, but what if the Chinese economy suffers a seriousdownturn?

Another potential concern is dwelling prices.

Australia saw a large run up in dwelling prices and household borrowinguntil a few years ago.

Some other countries that saw this subsequently suffered painfulcorrections and deep recessions, associated with very stressed bankingsystems.

Can Australia escape the same outcome?

A further theme is the focus on the funding position of Australianfinancial institutions, insofar as they raise significant amounts of moneyoffshore.

Could this be a weakness, in the event that market sentiment turns?

Actually, this is another version of the old concern about the currentaccount deficit: what will happen if markets suddenly do not want to fundour deficit?

It has long been a visceral fear among Australian officials and economiststhat global investors will suddenly take a dim view of us.

The same sorts of concerns of organisations such as the InternationalMonetary Fund and the ratings agencies seem to lie behind a perpetualquestion mark about Australia and its financial institutions.

It is unlikely we will ever be able to change definitively the views of all thesceptics.

And let us be clearwe should welcome the sceptics. Perhaps some oftheir concerns are valid.



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The Reserve Bank gives a lot of thought to these issues; we certainly donot dismiss them.

We should always be wary of the conventional wisdom being too easilyaccepted.

We should never, ever, assume that it couldnthappen here.

It is in that vein that I wish to pose a set of questions that are thrown upby these sceptical views. In particular:

- How much of the recent relatively good performance was due to luck?

- To what extent did we improve our luck by sensible policies, across a

range of economic and financial fronts?

- Are there signs of any of the things going wrong that people typicallyworry about?

- And if there are, or were to be, such signs, could we do anything aboutit?

To begin, I shall re-state some key metrics.



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These charts really require no exposition (Graph 1, 2 and 3).

The message is clear. I t is fair to conclude that, given the circumstancesinternationally, the Australian economy has exhibited more thanacceptable performance over recent years.

This conclusion would stand whether comparisons were made eitheragainst most other countries, or against our own historical experience.

Why was it that Australia did not have a deep downturn in 2009 when somany other countries did?

And why was it that we have returned to reasonable growth, when othershave struggled to do so?

This question has been answered on numerous occasions.

There are several elements.



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First, the Australian banking system went into the crisis in reasonableshape.

To be sure, there were some poor lending decisions during the precedingperiod of easy credit and there was, in hindsight, too much reliance onwholesale funding.

But among major institutions, credit quality issues have turned out to bemanageable.

Asset quality was not as good among some of the regional banks, andeven less so among some foreign banks operating in Australia, but theproblems have not been insurmountable.

Some observers might counter that the banks received assistance withwholesale fund raising in the form of the government guarantee.

But the banks paid for that, and it was an appropriate response at a timeof massive market dislocation when all their peers were receiving likeassistance and much more.

Moreover the banks have neither had, nor needed, access to this for sometime now and the stock of guaranteed liabilities outstanding has fallen byabout half from its peak level, as issues mature or are repurchased

So our banking system, while not entirely free from blemishes, wasnonetheless in pretty good shape overall.

Banks were able to raise capital privately in the depths of the crisis. Thelowest rate of return among any of the major banks over a year during thecrisis period was about 10 per cent.

The Australian Government has not needed to take an ownership stake ina financial institution.

Second, Australia had scope for macroeconomic policy stimulus, whichwas used promptly and decisively.



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Interest rates were lowered aggressively, from a high starting point,lowering debt servicing burdens at a rapid rate.

The fiscal stimulus was one of the larger ones, as a percentage of GDP,among the various countries with which we can make comparisons.

The evidence suggests that these macroeconomic measures wereeffective in sustaining growth.

Thirdly, the rapid return to growth of the Chinese economy saw demandfor energy and resources strengthen again after a brief downturn in late2008 and the first couple of months of 2009.

This reversed the fall in Australias terms of trade, and in fact pushed

them to new highs, which led to a resumption of the historic investmentbuild-up that had already begun.

It benefited the whole of Asia, which staged a very pronounced V-shapedrecovery on the back both of the Chinese measures and things othercountries did themselves.

A fourth element that many people add is that the exchange rate fellsharply, which was an expansionary impetus for the economy.

But of course the exchange rate was responding endogenously to thevarious shocks and policy responses, and has since reversed the fall. I twas doing what it was supposed to do.

Perhaps the real point is that the right exchange rate system wasimplemented nearly 30 years ago, and that it was allowed to work.

So Australia had these things going for it.

Was this all just luck?

We could not deny that our geography thought for much of our historyto be a handicap because of the distance from European and Americanmarketscombined with our natural resource endowment has provided a



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basis for the country to ride the boom in Asian resource demand. We didnot create that, though we still have to muster the capability to takesustained advantage of it.

But a well-managed and well-supervised banking system is not anaccident.

Years of careful work both by banks and APRA went into that outcome.

Nor was the ability to respond forcefully, but credibly, withmacroeconomic policy just luck.

You dont suddenly acquire the credibility needed to ease monetarypolicy aggressively while the exchange rate is heading down rapidly.

Authorities in lots of countries would not feel they could do that.

At an earlier point in time we probably would not have felt we could havedone it either.

The credibility needed to do it comes from having invested in awell-structured framework, and having built a track record of success incontaining inflation, over a long period.

The floating exchange rate is an integral part of that framework. Likewise,

you canthave a major fiscal easing and expect it to be effectiveif there are concerns about long-run public debt dynamics, as recentdebate elsewhere in the world shows.

You need to have run a disciplined budget over a long period beforehand,so that the amount of debt you have to issue in a crisis does not raisequestions about sustainability.

In both the monetary and fiscal areas, of course, having used the scope we

had so aggressively, it was also necessary, as I argued in 2009, to re-investin building further scope, by returning settings to normal once theemergency had passed.



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So, yes, Australia has had its share of luck. But to explain the outcomes,we need also to appeal to factors that didnt just happen by accident.

Of course, that doesntmean we still couldnthave problems.

Even if success to date hasnt been due to luck alone, perhaps our luckcould turn so bad that all our efforts at good policy making could beoverwhelmed.

Let us then take a look at some of the potential pressure points thatpeople sometimes worry about.

The first is the Chinese economy.

One of the data series people pay a lot of attention to is the Chineseversion of the so-calledPurchasing M anagers Index.

The usual commentary surrounding such indexes invariably refers to the50 level as the threshold between growth and contraction in the sectorof the economy being examined.

But what have these PMIs actually been saying about the Chineseeconomy?

Properly calibrated, as in this chart, they suggest that growth in Chinasindustrial production has been running at about 5 percentage pointsbelow average, which means it is just under 10 per cent (Graph 4).

But it is a long way from a contraction.

We did actually see Chinese IP contract for several months in 2008; we arenot seeing that at present.



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The conclusion I draw is that the Chinese economy has indeed slowedover the past year or so.

It was intended that a slowing occur.

But the recent data suggest that, so far, this is a normal cyclical slowing,not a sudden slump of the kind that occurred in late 2008.

The data are quite consistent with Chinese growth in industrial output ofsomething like 10 per cent, and GDP growth in the 7 to 8 per cent range.

To be sure, that is a significant moderation from the growth in GDP of 10per cent or more that we have often seen in China in the past five to sevenyears.

But not even China can grow that fast indefinitely and there were clearlyproblems building from that earlier breakneck pace of growth.



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Inflation rose, there was overheating in property markets and no doubt agood deal of poor lending.

It is far better, in fact, that the moderation occur, if that increases thesustainability of future expansion.

Moreover, the Chinese authorities have been taking well-calibrated stepsin the direction of easing macroeconomic policies, as their objectives forinflation look like being achieved and as the likelihood of slower globalgrowth affecting China has increased.

Prices for key commodities are lower than their peaks, but are actuallystill high.

So far, then, the China story seems to be roughly on course.

It is certainly true that we will feel the effects of the Chinese businesscycle more in the future than we have been accustomed to in the past.

That presents some challenges of economic analysis and management.

But even so, it may be better to be exposed to a Chinese economy with ahigh average, even if variable, growth rate, than, say, to a Europe with avery low average growth rate that is apparently also still rather variable.

Next I turn to dwelling prices.

As everyone knows, dwelling prices rose a great deal over the decade ormore from 1995, and not just in Australia.

This occurred globally.

The fact that it was a widespread phenomenon is a hint that we should bewary of explanations that are solely domestic in their focus.

It suggests that the global dwelling price dynamic had a lot to do withfinancial factors and there is little doubt that finance for housingbecame more readily available.



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In various countries prices have subsequently fallen.

In the United States, for example, prices are down by about 30 per centfrom their peak, though they look like they have now reached bottom.

In the United Kingdom the fall was smaller at about 1520 per cent. In

Australia, the decline since the peak has been about 5 to 10 per cent,depending on the region.

There are of course prominent examples of particular localities or evenindividual dwellings where price falls have been much larger.

Scaled to measures of income, Australian dwelling prices on a national

basis have in fact declined and are now about where they were in 2002(Graph 5).

That is, housing has become moreaffordable.

Four or five years ago we supposedly had a housing affordability crisis.

Now it seems that the problem some people fear is that of housing

becoming even more affordable.

Are dwelling prices overvalued?

Its very hard to be definitive on that question.

There are two aspects to the claim that they might be.

The first is that prices relative to income are higher than they were 15 or 20years ago.

If this ratio is somehow mean-reverting, then either incomes must rise alot or prices must fall.



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None of this can be taken to say definitively that Australian dwellingprices are appropriate, or that there is no possibility they will fall.

It is a very dangerous idea to think that dwelling prices cannot fall.

They can, and they have.

The point is simply that historical or international comparisons, to theextent they can be made, do not constitute definitive evidence of animminent slump.

At the very least, the complexity of making these comparisons suggestswe ought to look at some other metrics in thinking about the housingmarket.

One would be the performance of the associated mortgages. Here, themain story is that not much has changed.

Arrears remain low and if anything have been edging down over the pastyear. That in turn is not altogether surprising given that debt servicingburdens have declined (Graph 7).



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As a result of lower house prices and therefore lower loan sizes, somewhatlower interest rates and a good deal of income growth, the repayment on anew loan on a median-priced house as a share of average income is now atits lowest for a decade (except for the emergency interest rate period in2009).

It is true that a low unemployment rate is a key factor helping here, but itis also true that the proportion of households that are ahead on theirmortgage payments is also highwith some evidence pointing to overhalfwhich would provide a buffer of some months for those households

in the event a period of lower income was experienced.

If we look at applications for possessions of dwellings, they have beenrunning at about 0.15 per cent of dwellings on an annualised basis.



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Such applications have actually declined since their peak in both NSWand Victoria, though they have risen over the past couple of years in WAand Queensland.

In the United States the most comparable figure for repossessionsforeclosures started peaked at over 2 per cent of dwellings.

The conclusion? We should never say a crash couldnt happen here, andthe Reserve Bank continues to monitor property markets and theperformance of mortgages quite closely, as we have for many years.

But it has to be said that the housing market bubble, if thatswhat it is,seems to be taking quite a long time to pop if thatswhat it is going todo.

The ingredients we would look for as signalling an imminent crash seem,if anything, less in evidence now than five years ago.

What then about funding vulnerabilities?

The pre-crisis period saw too much borrowing short to lend long, andtoo much reliance on the assumed availability of market funding.

Banks everywhere have been adjusting away from that model over recent

years, Australian banks among them.

The share of offshore funding has fallen, and its maturity has beenlengthened (Graph 8).



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The flip side of this is of course the rise in domestic deposit funding,which has occasioned such competitive behaviour in the market fordeposits.

Interestingly enough, while we have been told over the years howAustralian banks were doing the country a favour by arranging thefunding of the current account, they have stopped doing this over the pastyear without, apparently, any dramatic effects.

As measured in the capital account statistics, there has been a net outflowof private debt funding over the past two years, offset roughly by increasedinflow of foreign capital into government obligations (Graph 9).

This has occurred with a net decline in government debt yields and a netrise in the exchange rate.



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The current account deficit has, in other words, been easilyfundedwithout the assistance of banks borrowing abroad in fact, while theyhave been net re-payers of funds borrowed earlier.

A reasonable conclusion is that the degree of vulnerability to a globalpanic of any given magnitude appears to have diminished, rather thangrown, over the past few years.

It hasnt completely disappeared, and it would not be sensible to expect itwould, unless we were pursuing a policy of financial autarky. But there islittle reason to assume that Australian institutions are somehow unusuallyexposed to these risks compared with most of their counterparts overseas.

In the end, of course, any banks ability to maintain the confidence of itscreditors is mainly about its asset quality.



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That brings us back to lending standards, the macroeconomicenvironment, and so on.

One would think that, overall, things look relatively good in Australia,compared to the worlds trouble spots.

Think for just a moment about the holdings of government debt on thebooks of banks in any number of other countries, and about the state ofpublic finances of many of those countries.

The arguments I have presented amount to saying that some necessaryadjustments have been occurring gradually and reasonably smoothly.Chinas growth had to moderate.

It has slowed, but it hasnt collapsed. Housing values and leverage inAustralia couldntkeep rising. They havent.

Dwelling prices have already declined, relative to income, and it is in factnot obvious that they are particularly high compared with most countries.

Housing affordability has improved significantly; over 99 per cent ofbank-held mortgages are being serviced fully.

Banks have reduced their need for the sort of funding that might be

difficult to obtain in a crisis situation.

The current account deficit is being funded by a combination of directequity investment, and flows into high-quality Australiandollar-denominated assets, the latter at costs that have been falling.

In fact, the Commonwealth of Australia, and its constituent States, are atpresent able to borrow at about the lowest rates since Federation.

Markets do not, then, seem to be signalling serious concerns aboutAustralias solvency or sustainability.

But markets can be wrong sometimes.



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They can sometimes be too optimistic (and other times too pessimistic).So even though we dont face immediate problems, we should ask: what ifsomething went wrong?

Below I consider a few possibilities.

If the thing that goes wrong is a major financial event emanating fromEurope, the most damaging potential transmission channel would be ifthere were a complete retreat from risk, capital market closure andfunding shortfalls for financial institutions.

Let me emphasise, importantly, that this is not occurring at present and ifit did occur it would be a problem for a great many countries, not justAustralia.

But in that event, the Australian dollar might decline, perhapssignificantly.

We might find that, in an extreme case, the Reserve Bank along withother central bankswould need to step in with domestic currencyliquidity, in lieu of market funding.

The vulnerability to this possibility is less than it was four years ago; ourcapacity to respond is undiminished and, if not actually unlimited, is not

subject to any limit that seems likely to bind.

An alternative version of this scenario, if it involved the sort of eurobreak-up about which some people speculate, could be a flow of fundsinto Australian assets.

In that case our problem might be not being able to absorb that capital.

But then the banks would be unlikely to have serious funding problems.

If the thing that goes wrong is a serious slump in Chinaseconomy, theAustralian dollar would probably fall, which would provide expansionaryimpetus to the Australian economy.



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NUMBER 3

Kiyohiko G Nishimura: Inter-regionalfinancial cooperation another layer of

financial cooperation towards financialstability

Remarks by Mr Kiyohiko G Nishimura, DeputyGovernor of the Bank of Japan, at CEMLAs 60thAnniversary Commemorative ConferenceCentralBank Cooperation at the Beginning of the 21stCentury,Mexico City.

1. Introduction

First of all, I am grateful to the organizers for inviting me to the 60thAnniversary Commemorative Conference of CEMLA, a symbol offinancial cooperation between central banks in Latin America.

I am especially thrilled, because this is the ideal opportunity to discussinternational monetary stability and central bank cooperation from theintegrated perspective that spans Latin America and Asia.

Latin America and Asia are among the most developed regions in termsof financial cooperation.

Today, I would like to take the concept of financial cooperation one stepfurther by considering the topic of inter-regional financial cooperation.

Although the theme of financial cooperation at the global, intra-regional,and bilateral level has been discussed at a variety of international forumssuch as G20, I believe inter-regional financial cooperation, especiallybetween Latin America and Asia, represents another important layerbetween the global and the intra-regional or bilateral levels.



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The reason could be that the regions are geographically distant, and thusrelatively less influenced by each other, particularly in terms of tradeactivity.

However, this relationship had already begun to change during the era ofthe so-called Great Moderation, and has changed dramatically since theLehman shock and the recent European sovereign debt crisis.

In fact, the above-mentioned cross-country correlation shows asignificant increasesince 2008 in the correlation coefficients of all majorAsian economies, following a gradual increase in China and Japan a fewyears earlier.

Although geographical distance has not changed, our mutual

dependency in trade has dramatically increased since the mid-2000s,driven largely by China, and owing to significant improvements intransportation technology and a decline in various trade-related costs(Slide 2).



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Abundant savings in Asia have not been invested sufficiently within theregion, and have thus eventually been invested outside the region, such asin bonds in the United States and developed Europe.

To put it in a different perspective, the Asian financial sector remainshighly dependent on banks, indicating the underdevelopment of regionalbond and other capital markets.

Owing to such an unbalanced market structure, Asian economies areexposed to the risk that domestic asset prices become volatile because ofrapid global capital flows, resulting in a sharp increase in the volatility offoreign exchange rates.

Also, the immature local derivatives market makes appropriate

risk-taking transactions difficult, as risk-hedging instruments are limited(Slide 4).

Moreover, owing to their less-developed securitization markets, Asianeconomies do not sufficiently enjoy the merits of the securitization



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dollar-denominated bonds.

However, since 2005, the Fund has begun to include those denominatedin the local currencies of the eight members.

In addition, EMEAP launched an exchange-traded fund (ETF) called thePan Asian Index Fund (PAIF).

The PAIF was first listed on the Hong Kong Stock Exchange in 2005, andlater cross-listed on the Tokyo Stock Exchange in 2009.

As part of the ASEAN+3 process, the authorities have launched the AsianBond Markets Initiative (ABMI), aimed at promoting bond markets.

The most notable recent achievement is the establishment in November2010 of a trust fund in the ADB called the Credit Guarantee andInvestment Facility (CGIF).

The CGIF plans to start its credit guarantee operations for localcurrency-denominated corporate bonds issued in the ASEAN+3

jurisdictions in the third quarter of 2012 at the earliest.

At the Finance Ministersand Central Bank GovernorsMeeting in Maythis year, another new roadmap for the ABMI was proposed and endorsed

to further promote resilient capital markets in the region, for example, byimproving the regional credit rating system, developing small andmedium-sized enterprisesfinance and securitization markets, and raisingthe level of financial education.

To establish and enhance a currency swap network

The second response by Asian authorities to the regionsvulnerabilities isa project to establish and develop a mutual framework of U.S. dollar

liquidity provision, called the Chiang Mai Initiative (CMI).

Aimed at improving the regions resilience against external shocks, theCMI started building a bilateral currency swap network in the region,which involves a contingent claim on foreign currency reserves held by



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each ASEAN+3 authority.

The CMI has since enhanced its effectiveness by increasing its size andthe number of participants.

In fact, in March 2010, the authorities evolved the CMI framework fromits original bilateral swap arrangements to the multilateral Chiang MaiInitiative Multilateralization (CMIM ), which is a collectivedecision-making framework signed by all member jurisdictions in asingle contract.

To ensure the effective implementation of crisis prevention and actualU.S. dollar liquidity support, it is essential for the authorities to monitorclosely the regional economy and financial markets, and exchange views

on their respective macroeconomic policies.

The ASEAN+3 authorities thus established their own but independentsurveillance unit, called the ASEAN+3 Macroeconomic Research Office(AMRO), in Singapore in April 2011.

Recent efforts to enhance financial stability

In addition to the above-mentioned two projects, momentum is buildingamong Asian central banks to make cross-border collateral arrangements

(CBCAs), aimed at further enhancing financial stability in the region.

CBCAs are arrangements whereby a central bank provides local currencyliquidity by accepting foreign currency assets, such as sovereign bonds inforeign countries, as eligible collateral.

Such arrangements already exist in some advanced countries.

CBCAs are thought to be an effective framework particularly in times ofshort-term money market stress.

Foreign financial institutionsbranches and subsidiaries often lack stablelocal funding sources, such as retail deposits.



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Risk Management Presentation August 6 2012

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