Those who have worked at central banks for 15 years or more will have now witnessed two major financial crises that have put the role of these institutions in managing capital flows and financial stability under the spotlight.
The increase in global interconnectedness has created a number of new challenges for the monetary policies of emerging economies looking to stabilise their financial sectors, as the policies of other countries have a wider knock-on effect than in previous years.
The first was the Asian financial crisis of 1997-98, and the second was the global financial crisis of 2008-09. Looking back, both crises _ the global financial crisis in particular _ revealed three important dynamics underpinning the perpetuation of risk to financial stability posed by international capital flows.
The first was pro-cyclicality, which amplified the magnitude of risk taking funded by liquidity arising from large and persistent capital inflows in the run-up to the crises.
The second was the mispricing of risk encouraged partly by a monetary policy that was too loose for too long, which gave rise to excessive risk-taking, especially by financial institutions.
And the third was the weak regulatory and supervisory frameworks that allowed an under-capitalised banking system to over-leverage for an extended period, thereby exposing the banking system to a possible major liquidity problem should the flows suddenly reverse, notwithstanding an accumulation of large systemic risk.
In addition, at the micro level of financial institutions, the crisis also pointed to weaknesses in the governance structure of banks _ especially the failure of the boards of banks in risk-oversight and in providing misplaced incentives to bank managements to focus on short-term profits at the expense of the longer-term stability of the institutions.
These are the weaknesses that have become the main objectives of the recent financial regulatory reform launched worldwide, aimed at making the financial system across the globe less prone to crisis.
Key reform efforts include greater use of macro-prudential measures as a tool to reduce risk to financial stability and a new Basel III capital standard that calls for more and better quality capital _ with new rules that set additional conservation and counter-cyclical capital buffers including liquidity and leverage ratios.
They also include a recognised broader central bank monetary policy mandate that pays attention to financial stability risk in addition to the primary objective of price stability in the conduct of monetary policy.
These are the reform efforts now ongoing in many parts of the world, including Asia.
But despite what these reform efforts have set out to achieve, it seems the global economy has not gone very far in terms of crisis prevention and resolution _ the risk to financial stability remains substantial in the current global economic and financial situation.
Currently there are three developments that have stiffened the headwinds to global activity and depressed market confidence.
The first is the intensification of risk surrounding the future of the Euro.
The second is the economic slowdown across all the major economies, which poses a severe downside risk to the global economy with possible significant impacts on financial markets and the operation of banks worldwide.
The third is the uncertainty of how policymakers will respond to these developments and challenges, both in the advanced market economies and in emerging markets.
For Euro area economies, the key uncertainty is to do with steps that will need to be taken to secure market confidence as policymakers move towards a fuller fiscal and banking union.
For the US, the uncertainty is about how the impending US fiscal cliff and the longer-term fiscal challenge will be dealt with.
For emerging markets, it is about the most appropriate policy choice to cope with the greater-than-expected trade declines and the high volatility of international capital flows.
For many emerging markets in Asia, these issues are not new, but they are the ones that have to be dealt with. As for capital flows, while managing capital flows is not a new issue, the context this time is new, which makes managing capital flows more demanding and challenging.
First, capital flows this time round are a global phenomenon driven by large overhangs of liquidity as a result of loose monetary policies of the major economies. The new context is that capital flows now affect all emerging markets, rather than being country-specific.
Second, because of the interconnectedness of financial markets, the spillover effects and contagion this time round are stronger and much more far-reaching. This means one country's policies to counter capital flows can have unintended consequences on other countries because of the larger scale of capital flows or being redirected across borders.
And third, the global nature of capital flows makes policy responses by individual economies less effective. This is partly because the scale of the flows is much bigger and can overwhelm domestic policy response, but also partly because financial markets can relatively quickly find ways around the measures put in place, lessening the effectiveness of the response.
A case in point is the Brazilian tax on capital flows which was quite effective when first introduced. Soon after, financial markets found ways to live with the measure and were more or less ready for a similar one if other emerging market economies were to do it. These are some new challenges in the current situation.
Reflecting ongoing difficulties in financial markets and the global economy, net capital flows to emerging markets this year have been volatile and less robust compared to previous years. The Institute of International Finance estimated in June that net private capital inflows to emerging economies in 2012 will decline by US$118 billion (3.7 trillion baht) to $912 billion.
The outlook for capital flows to emerging markets for 2012-13 is also expected to be subdued. This reflects the unusually large downside risks to the global economy at this time.
Meanwhile, financial market volatility has increased, characterised by successive rounds of risk-on and risk-off situations. The high volatility of capital flows is expected to persist in the second half of this year as policy uncertainty is likely to remain.
What will be the implications of the current capital flows for financial stability in Asia? At the macro level, capital inflows affect recipient economies and financial markets in three ways.
First, they complicate monetary policy because of a possible overshooting of exchange rate which is distortive to trade and, if sustained, can lead to resource misallocation.
Second, they will significantly expand liquidity in the domestic banking system, and through pro-cyclicality and risk-taking, set the stage for rapid domestic credit expansion that could lead to high inflation, asset price bubbles and large and persistent current account deficits.
And third, sudden reversals of capital flows can be disruptive to the economy and detrimental to the banking system.
To manage these risks, the policy response by emerging markets has been to focus on first moderating the impact of capital flows on domestic financial markets _ normally through exchange rate appreciation, market intervention and monetary policy actions.
The second focus is on managing the macro implications of capital flows so as to reduce the risks to financial stability.
This includes policy measures such as monetary policy sterilisation, fiscal policy offset, macro-prudential measures and greater capital outflows by domestic residents. To deal with the consequences of capital flows, individual emerging markets must calibrate measures to best suit the context of capital flows they face.
In the current chapter of capital flows, the economies of the South East Asia Central Banks Research and Traning Centre (Seacen) have relied on greater use of macro-prudential measures, exchange rate flexibility and the resilience of the banking sector _ through forward-looking banking regulation and disciplined banking supervision _ to manage the impact of capital flows on the financial sector and the economy.
This is good policy making since policy flexibility, disciplined conduct of macroeconomic policy and financial system resilience are key to the better management of capital flows.
So far, the approach has proved successful, with the financial stability across the Seacen economies remaining intact. The challenge of capital flows, however, is not yet over as uncertainty about the global economy persists and global liquidity remains large, which means we should not be complacent about the issue.
Seacen comprises all 10 members of the Association of Southeast Asian Nations plus China, Fiji, Mongolia, Nepal, Papua New Guinea, South Korea, Sri Lanka and Taiwan.
Finally, one important way bank supervisors can contribute to strengthening an economy's capacity to deal with capital flows is to keep the soundness and resilience of the domestic banking sector intact through a continuation of regulatory and supervisory reforms.
So far, financial institutions in the Seacen economies have done a good job in weathering the impact of the global financial crisis.
Much of this is due to regulatory and financial reforms implemented in the Seacen economies that have resulted in a better capitalised banking sector with improved risk management and a stronger financial regulatory and supervisory framework. Such strengths have paid high dividends in terms of greater capacities of the economies and the financial sector to absorb shocks from a volatile global financial market, and to maintain financial stability in the face of large and persistent capital flows.
Still, many aspects of Seacen's financial sectors can be further improved, specifically to add more resiliency, efficiency and greater access to financial services. In this respect, the reform process _ especially the Basel III standard _ must continue, as they are relevant to banks in Seacen economies and to the resilience of the industry in the longer term.
Continuing with reform will help ensure that longer-term strength of the banking industry will benefit from continued improvement in capital, liquidity, governance and risk management, putting Seacen's financial services industries on a firm footing to support regional economic growth and financial stability.
Bandid Nijathaworn, a former deputy Bank of Thailand governor, is Chairman of the Thai Bond market Association and President and CEO of the Thai Institute of Directors.