policy action recent policy developments over the past few years we have “ re - invigorated ” the bank's own financial stability role. this has been reflected in a number of ways. in november 2004, we commenced publishing a twice - yearly financial stability report, as a complement to our quarterly monetary policy statements. we have also introduced a local incorporation and an out - sourcing policy for registered banks. the former requires large banks to be incorporated in new zealand, rather than operate as a branch of a foreign bank ( as has been the case with westpac ). the latter requires banks to manage out - sourcing of core banking functions in a way that does not compromise their ability to maintain a core operational capability should a service provider become unable or unwilling to provide those functions. the local incorporation and outsourcing policies have been introduced mainly to improve the resilience of the new zealand banking system in a bank failure situation. that is a situation that we all hope falls into the " rare event " category, though we know from experience that bank failures can and do happen. and we know that there is a tendency for rare events to slip into the background, and in the case of those that could be very damaging, perhaps more than they should. one of the jobs of the reserve bank is to act as a counter to such tendencies. in parallel with progressing these issues, which affect mainly the large australian - owned banks, steps have been taken to strengthen the harmonisation and co - ordination of trans - tasman banking supervision. last year, the trans - tasman council on banking supervision was established, with a terms of reference which cover supervisory co - operation, preparedness for responding to crises that involve banks that are common to both countries, and whether legislative changes may be required to ensure apra and the rbnz support each other in their regulatory responsibilities, at least regulatory cost. the council recommended some legislative changes, for enactment in both australia and new zealand. dr cullen and the australian treasurer announced following their annual meeting that both governments will be promoting those legislative amendments. currently we are also involved in the government contingency planning for a possible influenza pandemic. besides making contingency plans to maintain our own operations, we have been working with the banks to ensure that business continuity planning is in place, and that key payments systems and cash distribution arrangements could be adequately maintained in the unlikely event that an influenza pandemic would impact on staff availability. we have been consulting with banks

discussed further in chapters 16 and 25, a number of reforms have already been adopted in response to the shortcomings in the design of the euro area, but it is not certain that they will suffice to preserve the currency union in its current form. forecasting near - term developments in the euro area crisis is beyond the scope of this report, however. the results of the reforms made to date have not yet been fully tested. if they prove inadequate, the crisis could be amplified and, in the worst - case scenario, could have severe repercussions for the future of the euro area in its current form. if they are successful, the reforms could strengthen the eurozone. the outcome has yet to be determined. 1. 4 euro area membership : pros and cons for iceland according to the conventional economic theory of optimal currency areas ( oca theory ; see chapter 5 ), a given country is better suited for participation in a larger currency area the more its shocks are symmetric with shocks to the other countries in the currency area, the more open its economy is, the greater the share of trade is with the currency area, and the more flexible its labour market is. these oca criteria centre on the balance between the cost of relinquishing monetary independence and the benefits of reduced transaction costs for trade ( see also chapter 6 ). if economic shocks hitting the candidate country and the currency area are symmetric, joint monetary policy will respond effectively to them, and a flexible exchange rate will not be needed as a shock absorber. the greater the share of external trade, the greater the benefits in lower transaction costs deriving from participation in a monetary union. at the same time, the effects of nominal exchange rate movements on the real economy will be less, particularly in small, open economies that price their exports in foreign currency and face given import prices in foreign currency. in other words, changes in the nominal exchange rate will have a smaller and more short - lived effect on the real bis central bankers ’ speeches exchange rate. finally, if economic shocks extend only to the home country and joint monetary policy is insufficient to absorb the shock, labour market flexibility could take the place of nominal exchange rate adjustment once the domestic currency has been abandoned. consideration of these criteria based on historical data does not produce an unequivocal answer about iceland ’ s suitability as a member of the eurozone. the icelandic business cycle has been rather weakly linked to that of the euro area – and actually