Credit flows to corporations have been affected by the heightened risk aversion of domestic banks as well as by some pull-back by global banks. A few economies have experienced considerable capital outflows. The economic contraction will certainly affect the loan books of banks. Should the downturn be deep and prolonged, the resilience of banks with weaker risk management systems will be severely tested. It is necessary to remain vigilant. However, Asia’s economic performance and policy responses so far provide assurance that the medium-term growth story remains compelling. FDI and domestic investments have increased over the years, and intra-region production networks have deepened. Both the hard and soft infrastructures have improved significantly in the last decade. Domestic consumption’s contribution to growth has grown steadily, and will play a bigger role in future. The drive towards deeper regional integration remains unabated. Just days ago, ASEAN signed the Agreement Establishing the ASEAN-Australia-New Zealand Free Trade Area, and re-affirmed its commitment to implement the ASEAN Economic Community. One important question for many participants here today is the policy direction of Asian governments towards the financial sector. I believe that authorities in the region will continue with the twin track of developing the banking system and capital markets. The importance of a well-functioning financial system in supporting economic growth and wealth creation is well recognised in this region. The need for funding to promote investment, develop infrastructure  4  BIS Review 30/2009  and facilitate urbanisation will return.

In a world in which the credibility of the central bank to keep inflation low is well anchored, the solvency of most agents is taken for granted and markets are well organised and hence liquid, interest rates remain low across the whole maturity spectrum and valuations high; changes in key rates do not affect inflation expectations that remain low and changes in real interest rates allow monetary policy decisions to be effectively transmitted to the economy. In normal times, interactions between central banks and markets are therefore important but fairly unintrusive:   Central banks influence markets through changing the level of short-term interest rates; they explain the rationale behind their interest rate decisions in order to improve the quality of economic agents’ expectations; they put in place technical mechanisms to promote liquidity on certain key market segments, for example by establishing the list of assets eligible as collateral in their refinancing operations or by setting up a discount window that ensures that banks with unexpected temporary requirements can refinance themselves.   While markets listen to central banks, central banks also listen to markets since the price formation in markets reflects agents’ expectations, in particular concerning inflation, and their assessment of risks; central banks require such information to make their analyses and take their monetary policy decisions. The smooth functioning of markets and financial stability are therefore essential for the effective transmission of monetary policy.