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Mr Andrew D. Crockett, General Manager, Bank for International Settlements, Switzerland, greets Dr C. Rangarajan, Governor of Andhra Pradesh, in Hyderabad on Monday. Ms Crockett is also seen.

HYDERABAD, Jan. 28

THE Bank for International Settlements (BIS), based at Basle in Switzerland, favours the development of local bond markets to help countries reduce both their maturity and foreign exchange mismatches.

One of the key factors behind the currency crises in the East Asian economies becoming a simultaneous crisis for the local financial systems, was the inherent mismatch in the banking system's balance sheets.

According to the BIS General Manager, Mr Andrew D. Crockett, domestic banks in those economies had frequently borrowed for the short-term in foreign currency and lent long-term in the local currency.

Even when lending was nominally short-term, it was often for projects such as real estate development, where cash flow generation occurred only in the longer term. And, even where local lending was nominally in dollars, it was often to borrowers whose income stream was in the local currency.

Stating that these `hidden mismatches' should be attended to in preventing crisis, Mr Crockett said a lesson from the crisis was that market development can help risk management. Concentrating risk in the banking sector increased the systemic vulnerability of an economy.

"When the local bond markets are not well developed, the local firms are forced to get long-term finance from abroad, exposing themselves to foreign exchange risk,'' he said.

According to him, another mechanism to reduce crisis vulnerability was through more active monitoring and management of the profile of external debt and liquidity.

"Holding adequate reserves, spreading the maturity of official borrowing, and monitoring the exposure of the private sector can help limit the risk of a country being sucked into a crisis when the international capital markets are disturbed,'' Mr Crockett said.

However, according to Mr Crockett, the single most important choice a country makes in its international economic policy is its exchange rate regime."This choice has an important bearing on a country's vulnerability to financial crisis. Fixed rate regimes have repeatedly been shown to be crisis-prone. The latest example is that of Argentina. So, although fixed regimes have a number of benefits, notably in providing an anchor for domestic monetary policy and a stable environment for international trade, in most large economies, the costs outweigh the benefits. A measure of exchange rate flexibility is, therefore, a key feature of reducing vulnerability to crisis.''

On the development of standards and codes that strengthen the operation of national and international financial systems, Mr Crockett said the fundamental prerequisite for an effectively functioning market economy was a legal structure for the definition and protection of property rights.

"Its absence was in large measure the cause of the initial difficulties experienced in many countries, making the transition from centrally-planned to market economies. A market economy needs a well-designed system of contract law, and speedy and impartial law enforcement. It also needs a basis for assessing the value of claims when contracts are not fulfilled. Beyond the basic legal infrastructure, a market economy needs a recognised set of accounting conventions, robust auditing standards and effective corporate governance,'' Mr Crockett said.

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