Traditionally, finance ministries have counter-cyclical fiscal policies and monetary authorities have counter-cyclical monetary policy tools at their disposal, but these tools are macro in nature. As a remedy to pro-cyclicality at micro level, counter-cyclical multipliers can be developed and used to dampen the pro-cyclical factors such as the risk weights that come out of the internal rating-based exercises. To begin with, as mentioned above, it may become necessary for financial stability authorities to develop a set of prosperity indices from which counter-cyclical multipliers can be derived. There already exist a multitude of private sector indices linked to business cycles, investor and consumer sentiments. Prosperity indices can be built on the basis of these indices. During market boom, everything points to the up-tick, market exuberance prevails, and prosperity indices are high. As a contrast, during economic downturn, the opposite holds. Once prosperity indices are available, the derived counter-cyclical multipliers can be applied to the pro-cyclical factors such as risk-weights mentioned above, default probabilities for credit rating purposes and discount (i.e., haircuts) percentages for various collaterals used in financial transactions. In suitable forms, they can be applied to other pro-cyclical factors too. One example of using them is to apply a multiplier greater than 1 (say, 1.5. Please note this is only an example and the actual multiplier is determined by specific calculations. The same applies below) during economic upswing and another multiplier less than 1 (e.g., 0.7) during downturn to the IRB-based risk weights to alleviate the pro-cyclical problems. The magnitude of the multiplier can be refined by taking into consideration other factors such as product type, industry and country of risk exposures. Through the applications of the counter-cyclical multipliers, we can not only mitigate the pro-cyclicality elements in capital requirements but also improve quality of capital by improving management of collaterals?? and by using multipliers-adjusted default probabilities and better managing the risk in complex credit products.

To stabilize markets under severe stress, finance ministries and central banks need to act fast and apply extraordinary measures. Untimely or delayed response falls behind the curve and would make the outcome less than desired even if the response is correct and strong. In modern Western societies, a prolonged political process for mandates to finance ministries or central banks often miss the best timing for action. We have observed such cases during the current crisis. Going forward, national governments and legislatures may consider giving pre-authorized mandates to ministries of finance and central banks to use extraordinary means to contain systemic risk under well-defined stress scenarios, in order to allow them to act boldly and expeditiously without having to go through a lengthy or even painful approval process. Such systematic pre-authorized mandates would put the specialized expertise of finance ministries and central banks to the best use when markets need it the most.

3. China's financial sector reform and ongoing macroeconomic stimulus measures

In 2003, fully aware of the systemic vulnerabilities of China's banking industry, the Chinese government made a courageous and strategic decision to restructure the four state-owned commercial banks. It was commonly recognized at that time that Chinese banks, especially the big four, could hardly withstand a big economic downturn if not seriously reformed. The banking system was then vulnerable to shocks, especially external shocks, which would trigger confidence crisis or even systemic meltdown. The Chinese government decided to first inject capitals into Bank of China and China Construction Bank by tapping into the official foreign reserve. The banking reform got a quick start and captured a good time window. Before the reform, Industrial and Commercial Bank of China (ICBC), CCB and BOC were plagued by high NPL ratios, low or negative capital base and a culture not accountable to shareholder value.. Through capital injections and subsequent public listings, these major banks now enjoy strong capital base even after fast growth during the last five years. Through NPL carve-out and strengthening of risk management practices, all of these banks have maintained NPL ratios of low single digits. In terms of corporate governance, boards are comprised of independent non-executive directors and full-time and dedicated directors who can provide strategic guidance for future development and effective checks and balances. Strategic investors from overseas were brought in to help them improve in areas of weakness such as risk management, business processes, product innovations, cash management, and credit cards and so on. More importantly, through the restructuring processes and public listings and the transparency that followed, accountability culture started to sink in and shareholder value became respected, not ignored as before.