However, to have an impact on the real economy, there must be a way to transmit this signal all the way to the financial activities that determine economic transactions, such as business capital formation, household consumption and savings. The traditional channel is through commercial banks. And now we have another channel through the corporate bond market. This channel is poised to grow more rapidly in the future. The second aspect is that central bank also operates in the government bond market in its conduct of monetary policy. It can sell and buy bonds to pump money in or out of the system, through their open market operations. An efficient, deep and liquid bond market therefore will not only help make the intermediation process competitive and active - but also allow the central bank to transact in the market more effectively. The third aspect is the function of the bond market in managing the capital flows. Emerging market economies when they are successful tend to attract capital inflow very quickly, and in very large quantity. Unfortunately, if things turn bad, the outflow of capital can also be equally quick and in as large a quantity. How can one better manage this volatile capital flow? To some extent, I think the risks can be mitigated with a well functioning bond market.
If we can make it function as a temporary reservoir to store the incoming water, and more slowly releasing it to the various users of fund within the country, at the right pace for absorption - if the market selection process can be made such that only the projects with really viable, economic prospects are granted the fund - and, if the foreign owners of fund can be persuaded to hold the instruments denominated in borrowers’ own currency, thereby shifting the position on the foreign  2  BIS Review 48/2002  exchange risks from the borrowers to the investors, then the bond market can be a safer channel for capital flows than the commercial banks. At this point you may disagree that if foreign investors in bonds want out, they will still sell the bonds, causing the prices to be sharply lower anyway. This is true. But price volatility in the bond market is still better than a run on your banks. Therefore an efficient bond market can help lessen the adverse impact that volatile capital flows may have on the financial institutions. A sound financial system is of course a necessary condition for the conduct of monetary policy. The role of non-bank financial institutions Let me now turn to the non-bank financial institutions. What can be your roles in relation to monetary policy? I can offer four suggestions. Number one, you can make yourself an efficient player in the market. The more efficient the competitors, the better the market is.