glenn stevens : developments in financial regulations address by mr glenn stevens, governor of the reserve bank of australia, at the annual dinner of the australian business economists, sydney, 8 december 2009. * * * the financial crisis that engulfed global capital markets and brought a number of important international banks close to the brink last year has been followed by a good deal of soul searching among the regulatory community. in several countries, though not in australia, regulatory structures and / or practices have been seen as inadequate. work is proceeding to try to establish better arrangements so as to prevent the next crisis, or, more realistically, at least make it less costly – all the while seeking to avoid doing things that make it harder to recover from this one. i propose to offer today some information and some observations about these developments and the associated issues. i won ’ t go into the causes of the crisis per se ; these have been covered at length before. the material offered is set in a global context, rather than an australia - specific one. just to be clear, if in the following paragraphs i am saying something about australia, i will make that explicit. lessons from the crisis what conclusions have governments and regulators around the world drawn from this episode? there are many. but the most important ones can be organised under five relevant headings. first, capital : there was not enough. in the case of global banks ’ trading books, a lot of risk accumulated and was not well measured. capital held against complex structured products in particular was seriously insufficient. a good deal of risk was also supposed to be “ off balance sheet ”, but returned very quickly to major institutions once liquidity dried up. moreover, some instruments were considered to be “ capital ” but could not really absorb losses, at least while a bank remained operating. second, liquidity : not enough attention had been paid to the risk that, in the event of some market shock, funding liquidity could become much more difficult. comfortable assumptions that markets for some instruments would remain liquid proved to be unfounded. third, the so - called “ shadow banking system ” : there were systemically important activities going on outside the “ regulatory perimeter ”. this included the activities of investment banks, hedge funds, finance companies, money market mutual funds and institutions that often had close ties to banks, such as special purpose vehicles ( spvs ), structured investment vehicles ( sivs ) and conduits. these entities were typically less closely supervised or unregulated,

earlier fears about 2002 were not going to be realised. the us economy grew more quickly in the final months of 2001 and the first quarter of 2002 than anyone had expected. in addition, we received better news from non - japan asia and europe. it is now pretty clear that 2002 will be a year of recovery for the world economy, and the imf is forecasting good growth through the year. the debate is no longer about whether there will be a recovery, but about whether it will be an average or below - average recovery. there is still a good deal of uncertainty about how robust the us recovery will be once the inventory correction has passed, i. e. in the second half of the year. some of the bubble - type distortions have not been fully unwound so there is still a fair bit of caution around, including in the federal reserve board. so we are in a world economy with a more comfortable outlook than a year ago, but with still some uncertainties remaining. what of the australian economy? the story here has been much less exciting, but the results a lot more satisfying. as you know, gdp grew by 4. 1 per cent over 2001, which was the highest among comparable oecd countries. we can now safely claim that the australian economy has weathered a world recession without itself experiencing one. this is the first time in my experience that such an outcome has occurred, and it must give us confidence in the soundness of our economy. but before getting carried away, we should concede : • by the standards of earlier world recessions, last year ’ s was a mild and short one, and some observers may be reluctant to classify it as a fully - fledged recession. • we did not escape scot - free. if you average our growth in 2000 and 2001, it comes out at 3 per cent so we did experience a modest slowing. as well as good gdp growth, we have experienced quite good employment growth over the past year. it appears that the slowdown in our economic activity resulted in a trough - to - peak rise in unemployment from 6 to 7 per cent, and that half of the rise has already been whittled away so far in 2002. this is extremely good news because it is the first time for three decades that we have been through an international downturn that has resulted in the peak unemployment rate in australia being lower than its predecessor. at this point in proceedings, i usually review the previous set of forecasts i