A flexible exchange rate should help mitigate this risk. In addition, the development of the foreign exchange derivatives market should allow private agents to hedge against currency risk. In addition, capital inflows may be behind the development of bubbles in domestic asset prices, and there are also macro tools to deal with them. However, there are other risks that must be considered, which have implications on macro prudential regulation. Note that these risks may be relevant even when net capital flows are limited. Therefore, from the standpoint of financial stability, gross flows become relevant determinants of fragilities. These risks associated to capital inflows are: funding and credit risks. Regarding funding risk, large capital inflows in the form of short-term loans to local banks will tend to increase banks’ dependence on this external funding source, which has been shown to be a volatile source of funding. From the point of view of central banks, the accumulation of reserves may help mitigate the economy-wide consequences of this risk, but the soundness of the banking system must be safeguarded with the proper regulation. As for credit risk, large capital inflows in the form of loans to local banks and portfolio debt securities may translate into an increase in the credit supply as local intermediaries and corporations access more elastic and often cheaper sources of funding (beside currency risk).
Policy autonomy It is now widely accepted that a broad policy toolkit and pragmatic policymaking are paramount in dealing with multiple challenges. Unconventional and unprecedented policies are no more heresy. This shift in mindset is a very welcome change. If only this mindset had persisted during the AFC, our experience in the region would have been much more positive. Experience also suggests that policy autonomy is critical in deploying measures in an environment with no precedent. Especially when the essence of the problems is domestic in nature, compounded by the specificity of each economy’s operating and legal environment, political and social structures. 3/5  BIS central bankers' speeches  Policy prescriptions will be least effective when it is not ‘owned’ by the domestic policy maker or when it is not independent of external influence and coercion or when policy being administered is more a reflection of ‘consensus economic’ thinking. External influence can be viewed from two aspects. External developments that transcend national boundaries; and external players that may directly or indirectly suppress domestic autonomy. The former has been greatly discussed, where financial liberalisation and globalisation have worsened the trade-offs for monetary policy to achieve its multiple domestic objectives. Some consensus has also been reached on the ways to regain autonomy, in the form of broad policy toolkit to prevent overburdening of any single policy instrument, the buildingup of buffers and instituting the necessary structural reforms that serve to fortify the economy.