Regulatory authorities face two challenges that need to be addressed forcefully if they are to contain a new source of systemic risk in international finance. First, the increasing migration of complex market activities to supervisory bodies that lack the necessary sophistication to oversee them; and, second, a growing threat of politically motivated changes to regulatory regimes.

There has been much talk recently about the extent to which the proliferation of derivative products has allowed banks to manage their balance sheets better. By enhancing the ability to hedge and shift various risks, advances in what is called “credit risk transfer” technology have lowered the vulnerability of the international financial system to any individual bank crisis.