CRISES never seem to occur where expected. This (global financial) crisis did not originate where many feared it would - in hedge funds - but in the most regulated, the banks.

Moreover the biggest problems were not seen in international banks, but in domestic banks, as we saw in the UK.

The lesson is that regulation is not the answer to everything. It needs to be the right regulation, not heavy regulation for regulation's sake.

Earlier I used an analogy of a car driving at speed. Let me stick with a car as an analogy. If I get into my car in the morning and turn the engine on I do not expect the car to blow up.

I should have a driver's license when I turn that key but I should not be expected to know how the engine works. Instead I should have trust and confidence that it will work without blowing up.

There is naturally a degree of self-regulation as car makers - like banks - do not want their product to blow up. But this is clearly reinforced by effective industry-wide regulation - any small change to an engine is tested and tried before being permitted - yet while the basics of a car (four wheels and an engine) have not changed, the industry has not been without its innovations.

Now banking is not the auto industry - but some of the general themes are relevant - we need to ensure that people have trust and confidence in banking and financial products, not fearing that they could blow up.

We must not overlook the importance of the basics of banking, the four wheels and the engine. Ideally there also needs to be the banking version of a driver's license - not that I recommend anyone be forced to take a test - and some basic understanding on the behalf of people and firms in terms of what they are doing.

Perhaps banks need to work with others in the financial industry and even educational authorities to help improve financial literacy and understanding.

As the fallout from the crisis was seen and felt, even experts in the banking and financial industry were surprised by some aspects, in particular:

1. The scale of the shadow banking industry. Just beyond where the regulatory boundaries stopped had emerged a sizeable industry of near-banks. The so-called shadow banking industry.

2. The scale of intra-industry financial activity. This went hand-in-hand, it seems, with greater complexity.

The crisis saw the use of complex derivatives, such as collateralized debt obligations (CDOs) on mortgages, and post-crisis analysis has highlighted the attractions of simplicity and transparency. Regulators will need to ensure that they have minimized the potential scale of the shadow-banking industry.

The scale of intra-industry financial activity has already led to calls for taxation of speculative-type activities - the so-called Tobin Tax. The idea is to impose a tax that applies to short-term, speculative transactions, but not to longer-term, economically driven transactions. I am not so sure. The trouble with such an idea is that it may work in theory but not in practice.

Yes, one wants to curb speculation, but it is hard to say which financial flows are short-term and long-term and - in a globalized world the lesson is that it is much harder to tax things that are mobile - such as financial flows.

In a speech last November to G20 finance ministers in Brazil, the governor of the People's Bank of China, Zhou Xiaochuan, drew parallels between the financial sector and engineering and control theory.

There were, he argued, too many positive feedback loops that implied risk. "What we need to do is not to totally rebuild the system, but to add a few negative feedback loops, which are able to sufficiently change the characteristics of our system," he said.

Blurred boundaries

During the early part of this decade, as the derivatives market grew, there was a deep debate. Some, like Alan Greenspan, Larry Summers and Bob Rubin, defended the growth of the industry and played down concerns.

Many others had worries, perhaps best summed up by the phrase attributed to Warren Buffet, that derivatives are like hell: easy to get into, impossible to get out of once there!

Recent years saw the distinction between banks and the markets become blurred, with financial disintermediation becoming an ongoing trend across all economies. In Asia, following the financial crisis of 1997-98 there was a move towards debt and equity finance. In the West, in the more developed financial centers, market completeness was seen as a desirable outcome.

New securities would help achieve such completeness. Innovation would thus improve efficiency. The idea was the ability to separate finance into its most fundamental pieces that would allow risk to go to those willing and able to bear it.

For instance, take a bond. There is always a risk of default. This risk varies across issuers. By breaking a bond down into a strip of coupon payments - to be made each year, say - and into a final principal payment, the bond has been broken into its fundamental make-up.

Now the risk of default can be better analyzed and insured against. This led to a widely held perception that, while bank-based finance was good, market-based finance was better.

Two years ago, to quote the Bank for International Settlements, "Not only did market-based finance give the finance systems access to a new class of people, it made it easier for financial institutions to manage their risks. The fact that such a wide class of assets could be bought and sold meant that adjustments were easy, cheap and fast. This made the financial system much more of a shock absorber than an amplifier!"

That was wrong. Securitization opened a breach in the traditional role of banks as risk monitoring devices. The so-called "originate and distribute model" for securitized products introduced a false sense of disintermediation.

(The author is chief economist of Standard Chartered Bank. The views are his own. Shanghai Daily adapted this article from his speech at a forum held by the China Europe International Business School and Caijing Magazine in Shanghai on September 5. )