for them not to be needed. there is trust between the borrower and the bank. the bank is trusting that the borrower will repay the loan. the bank can do a lot of due diligence on the borrower to be reasonably confident that the lender will repay. but ultimately there will be some trust involved. the bank needs to trust that the borrower has provided accurate information and will act in good faith. there will, however, always be a gap between what the bank can learn through its due diligence and what it needs to be completely confident the loan will be repaid in full. because the process of financial intermediation often has a number of links in the chain, there also needs to be trust between financial institutions. many financial transactions don ’ t just involve one bank lending out its deposits to the end - borrower. often the funds are on - lent to one financial institution after another, before ultimately finding its way to the end - borrower. so trust needs to be present at every stage in the chain. one breakdown in this chain of trust between counterparties can throw a spanner in the works of the whole process. ultimately there is only so much due diligence that can be done. risk is always present in the financial system. information asymmetries will always be present between the two parties in a financial transaction. transparency can reduce but not eliminate the risk from these asymmetries. bis central bankers ’ speeches finally, there has historically been trust between regulators and financial institutions. ( i am not sure there is all that much of this trust at the moment, as i will discuss later. ) “ trust me, i know what i ’ m doing ”, was the banker ’ s exhortation for the light touch approach to regulation that was pervasive prior to the crisis in many countries, most obviously the uk. the argument was that banks should be broadly left to their own devices, with the discipline provided by the market deemed sufficient to keep them on track. the breakdown of trust having described the critical role that trust plays in the process of financial intermediation, i will now describe how trust has broken down over the course of the financial crisis. the period leading up to the financial crisis saw what might be labelled, in the context of my talk today, the development of lazy trust. things were generally going along fine, so my due diligence was that i will take you, the lender, at

stage a number of possible hypotheses might be put forward : • the combination of lower equity and commodity prices might be signaling a weaker global outlook ; • it might simply be an indication that equity markets had previously been overvalued and in need of a correction ; or • the equity price falls might in part be an irrational response to commodity price falls and other economic data, or at least contain an element of overreaction to genuine signals. most likely there is an element of validity in more than one of these, and no doubt other hypotheses can be put forward as well. as i said, i don ’ t think it is possible to be definitive about these things, but it is relevant to note that market and media commentary often errs on the side of being unjustifiably gloomy. a few points can be made on that score : • first, as always, the recent equity price movements have to be put in perspective. this is not the first bout of nervousness in these markets : in the advanced economies there was a similar one late last year, from which markets subsequently recovered, and the recent declines reverse only a small part of the cumulative gains during the post - crisis recovery period. • second, there seems to have been relatively little new economic data in the early part of this year to trigger a significant reassessment of the global outlook. and even though the chinese economy has been slowing, it is still growing at a reasonable rate. • third, the hypothesis that falling equity and falling oil prices are inter - related responses to a weakening in global demand is hard to sustain. the falls in oil prices seem to be mainly driven by strong supply, not weak demand, as indeed has been the case for a number of other commodities such as iron ore. consistent with that, other non - energy commodity prices have been relatively stable during this recent period when oil prices have continued to fall. this has important implications for the general outlook. while an oil supply expansion could be expected to have a range of complicated effects on producers, consumers and holders of energy assets, it would normally be considered a net positive for the world as a whole. i think these points argue against putting an excessive focus on recent market movements. but, that said, there has clearly been an increase in market volatility around the word in recent times and a heightened focus on financial risks. implications of the global risk environment for australia at this point it is useful to ask how