Column : All connected

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: into bilateral contracts based on derivatives. These contracts used to enable all sorts of risks to be hedged, and the larger part of their value lay in finessing the contracts terms (principal, maturity and various contingencies) individually for the buyer. This is the part of the business that interconnects balance sheets. If (because of losses on its investments) a bank is unable to fulfil its obligations as a counterparty in the contracts it has entered into, the threat of triggering a cascade of defaults becomes a threat to financial stability and to confidence in the entire system.

Policy agencies can and do monitor the level of capitalisation of the banks from a financial stability point of view, and they monitor the degree of concentration of banking business, from a competition policy point of view. However, it is not clear that in the US or the UK they were monitoring the network structure of the deregulated anglo-american financial system. Indeed, it is not clear that there is any practical way in which they would have been able to track the evolving network as connections sprouted and spread through heterogeneous and sophisticated credit backed contracts.

Going forward, the proposal that OTC contracts be subject to exchange trading with the exchange serving as the counterparty to all traders (Ajay Shah, 27 September) has much to recommend it. This will of course mean that only a few types of standardised, and hence more transparent contracts, will exist.