And it is vital that the insurers fully understand the counterparty credit risk they are running, the quality of the collateral they are taking and how to manage the collateral in the event of default. The more recent developments in markets for Exchange Traded Funds (ETFs) are another example of financial innovation and growth in a previously small market. ETFs are in principle a “good” financial innovation – for example, they offer retail investors a cheaper way of getting exposure to the underlying asset (by cutting out the fund manager) and provide a very liquid asset. Nonetheless, the rapid growth in ETF assets under management – which have increased seven-fold since 2003 (Chart 15) – merit attention, given it has been characterised by increasing complexity, opacity and interconnectedness, and as some practices, if left unchecked, could grow to pose risks to the stability of the financial system.12  10  That could come about not only through the low yields on safe assets, but also through an increase in the correlation amongst safe assets, which might prompt reserves managers to seek new diversification opportunities, some of which might be met through financial engineering. 11  These products are discussed in more detail in the box on pages 168–169 of the 2010 Q3 Quarterly Bulletin. 12  The Bank first discussed ETFs in a box on pages 40–41 of the June 2010 Financial Stability Report.
MAS is involved in the discussions on both the capital and liquidity proposals and supports the broad thrust of these initiatives. As MAS’ regulatory framework has generally been regarded as conservative, we are in a good position to comfortably adopt these more stringent standards. However, we are aware that more regulation on its own is not a panacea. It would be undesirable for the regulatory pendulum to swing towards extreme conservatism and for over-prescriptive rules to severely restrict financial innovation. MAS will adopt a balanced approach and will work closely with and consult all stakeholders in implementing the new regulatory standards. Role of industry participants Supervision has to work in concert with effective risk governance in the financial institutions. The Boards and senior management of financial institutions must take ownership and responsibility to manage risks. A report issued by the Senior Supervisors Group 2 in March 2008, on observations on risk management practices highlighted many risk management practices that improved the resilience of financial institutions during a crisis. Let me highlight three areas. First, effective capital planning. Banks need to conduct a thorough and comprehensive assessment of their levels of capital. These have to be “forward-looking”, taking into account the nature and level of the bank’s risk, not only under “normal” business conditions, but also  2  The Senior Supervisors Group comprises senior financial supervisors from seven countries (United States, Canada, France, Germany, Japan, Switzerland, United Kingdom). It is chaired by William L. Rutledge from the Federal Reserve Bank of New York.