limits, but their share in total exports is still small. the next crossroads stems from the vast improvement in iceland ’ s foreign liquidity and the build - up of the foreign exchange reserves. as of the end of february, the reserves totalled 719 b. kr., or 46 % of gdp. iceland ’ s foreign reserves have never been larger as a share of gdp, not even at the end of world war ii. increased reserves, enhanced stability, progress in the implementation of the plan to achieve a fiscal surplus in coming years, and buybacks of treasury foreign debt in the secondary market have silenced the voices that prognosticated sovereign default. these factors contribute to the assessment that it is now considered safe to start removing capital controls on outflows and that the conditions have improved markedly for treasury foreign borrowing, which could pave the way for other domestic entities. the icesave referendum taking place this coming weekend could, of course, affect these prospects. if the “ yes ” vote carries the day, plans for capital account liberalisation and treasury borrowing will proceed as currently planned. if the icesave agreement is rejected, however, there are indications that two major credit rating agencies will decide to downgrade bis central bankers ’ speeches iceland ’ s sovereign debt to sub - investment grade. this would impede foreign borrowing and delay capital account liberalisation, although it is not clear how strong or persistent these effects would be. the financial system is at a crossroads as well. the first phase of financial system reconstruction is largely complete. iceland ’ s banks have defined balance sheets, private sector debt restructuring is underway, and changes have been made in order to address the most obvious flaws in the regulatory framework governing domestic financial institutions. a number of tasks remain unfinished, however, as regards establishing a stable, effective financial system. it is not yet possible to state with certainty that financial institutions could fund themselves without the support of capital controls and the declaration of a blanket deposit guarantee. in this context, it is critical to enhance the functioning of the financial markets, which are important for trading, funding, and risk diversification – particularly the foreign exchange and equity markets. it is also essential that financial institutions and other entities re - establish their access to foreign credit markets. a further task is to formulate policy regarding the nature, size, and international relations of the icelandic financial system. it is no less important to formulate policy concerning the tools and institutional structure for financial stability : the financial crisis has

ric battellino : central bank market operations address by mr ric battellino, deputy governor of the reserve bank of australia, to the retail financial services forum, sydney, 28 august 2007. * * * central bank market operations around the world have been in the news in recent weeks, so i thought it might be useful to take this opportunity to run through those developments. while this topic may seem somewhat distant from retail financial services, there is in fact a strong relevance to today ’ s conference, because much of what central banks do in financial markets eventually flows through the whole financial system, including retail services. background the reserve bank has been using market operations to implement monetary policy since the 1980s. 1 essentially, this involves dealing in markets to influence the interest rate on overnight funds in the money market – also known as the cash rate. central banks are able to closely control the overnight interest rate because they have unlimited ability to inject funds into, or withdraw funds from, the money market. this model for implementing monetary policy is now fairly standard across the developed world. the reserve bank board sets the stance of monetary policy in terms of a target for the cash rate because this rate ultimately influences the broad spectrum of interest rates in the money and capital markets and the interest rates that intermediaries charge on loans, including those in the retail market. in effect, all interest rates in the financial system are determined in one way or another relative to the cash rate. by targeting the cash rate, central banks are therefore able to exert broad influence over the overall cost of credit in the economy and, in turn, economic activity and inflation. after the reserve bank board has decided the target for the cash rate each month, the domestic markets department of the bank is responsible for keeping the actual cash rate in the market as close as possible to the target over the ensuing inter - meeting period. a major determinant of the cash rate is the aggregate level of balances held by commercial banks in their exchange settlement accounts at the reserve bank. these are the funds that banks rely on to meet their daily settlement obligations to each other and to the reserve bank. if banks do not have enough of these funds, they risk failing in their payments, so a shortage of funds causes banks to bid more aggressively in the money market to try to restore their holdings. on the other hand, because these funds earn an interest rate that is below the rate that could be earned in the market ( 25 points below the cash rate ),