The swift development of financial market and real economy over the last decade had led policymakers in some major economies believe that the existing regulatory structure was effective. Few measures were taken to enhance the regulatory framework to keep pace with the emergence of new products, new institutions and new markets. Since the breakout of the crisis, cases have proved that due to the lack of coordination among regulatory agencies and communications between regulators and central banks and finance ministries in some advanced countries, efforts to rescue financial institutions and stabilizing markets were hampered.

(3)Effective international regulatory cooperation yet to be in place

Due to the lack of consistent regulatory standards and a platform for effective information exchange, regulators do not have a good understanding of the cross-border activities of internationally active financial institutions. In particular, there is a lack of understanding of international capital flows. Relevant international organizations were pre-occupied with macroeconomic surveillance, especially with respect to the exchange rate regimes of emerging economies. Its work on monitoring international capital flows is insufficient. So far, we still do not have a good understanding of the channels and mechanisms of cross-border fund flows, especially flows to and from the emerging market economies, and how these flows reverse in unfavorable times.

To enhance international cooperation in financial regulation, the Financial Stability Forum has identified 30 large internationally active financial institutions for which supervisory colleges have been established. In due course, we should assess how effective and sufficient these colleges are in strengthening international supervision of cross-border financial institutions. And IMF should also include regulation and surveillance of international capital flows as an important part of its early warning system.

2.Issues meriting special attentions in reforming the financial regulatory system

(1)Reform begins with self-criticism

One ancient Chinese philosopher once said, "(w)e should self-examine ourselves three times daily." This epitomizes the oriental philosophy on the importance of self-criticism in improving oneself. In analyzing the root causes of and drawing lessons from the current crisis, such spirit is sorely needed. Only by looking inward with this spirit, can we draw the right lessons and avoid being blindsided. Only with the right lessons learned, can far-reaching reforms begin. Recently, there have been some blaming games, which intend to hold others responsible for the on-going difficulties. Such lack of remorse does not help in examining the flaws in the existing financial regulatory system.

In fact, lack of remorse is one key factor leading to the current crisis. Before the crisis, there was a prevalent complacency. Although the US regulatory structure was a complex patchwork of fragmented agencies and jurisdictions, some believed that it worked quite well. Though some made efforts to address issues, most are reluctant to take a serious crack at the problems with an excuse of "(i)f it ain't broke, don't fix it." The cost of waiting for the system to break has turned out to be tremendous. Against this backdrop, we should begin with an attitude of self-criticism while addressing the challenges of financial regulatory reform.

(2)Introduce counter-cyclical multipliers to strengthen counter-cyclical mechanism

Effectively addressing the pro-cyclicality elements in the existing capital requirement framework and improving quality of capital is essential for preventing serious financial crisis. The ongoing crisis has exposed vulnerabilities in capital adequacy requirements of banks in the following areas: (a) the Basel II framework does not adequate capture risks of complex credit products; (b) the minimum capital requirement and the quality of capital have not provided adequate buffer during the crisis; (c) the pro-cyclicality of capital adequacy has amplified volatilities; (d) there exists the differences in capital requirements among different types of financial institutions.