philip lowe : remarks to the asian development bank – institute of global finance international conference remarks by mr philip lowe, deputy governor of the reserve bank of australia, to the asian development bank – institute of global finance international conference, sydney, 8 september 2016. * * * i would like to welcome you all to sydney to this important conference. it is fantastic to see the asian development bank working so closely with an australian university, the institute of global finance at the university of new south wales. it is also very pleasing to see that this collaboration is occurring in this beautiful city. i am sure that you will find this conference stimulating and that you will receive warm hospitality in our city. the title of this conference is long. ten words : “ financial cycles, systemic risk, interconnectedness, and policy options for resilience ”. it is also challenging. i say this because just below the surface of these 10 words lies a host of complex and difficult issues. the proper functioning of our modern economies depends on us understanding and addressing these issues as best we can. if we get things wrong here, the outcomes can be really bad : our economies will be more volatile, job security will be less and people ’ s hardearned savings will be at greater risk. the global financial crisis was a powerful reminder of this. so the issues that we will discuss at this conference really matter. it is appropriate that the discussion is taking place at an international conference, which features distinguished speakers from the region and elsewhere. after all, financial stability is a global issue : instability in one country can ripple right around the world. and many of the reforms to address instability are best accomplished internationally. we can also learn a lot from one another ’ s experiences. in my remarks this morning i would like to highlight three specific questions that are suggested to me by the conference title and papers. these questions are : i. how can we make our financial systems more resilient, particularly in a world in which capital flows easily across borders? ii. how should we characterise and respond to episodes of financial boom and bust – the financial cycle? iii. what determines the amount of systemic risk we are exposed to, and how can we identify and analyse it? the positive news is that in each of these three areas much has been learnt since the crisis. the not - so - positive news is that our answers to these questions are still incomplete and, just as one issue is resolved, too often another seems to emerge. i

into account the myriad influences that are at work. close analysis and good judgement are both needed to do this. a related research question is how policy should respond to a systematic weakening of balance sheets. this question is the subject of a lot of research at present, much of it prompted by work at the bank for international settlements ( bis ). the work at the bis, though it has focused heavily on aggregate credit as the indicator, has advanced the hypothesis that, in some circumstances, the build - up of financial imbalances may be a better guide to the sustainability of growth in the economy than is the current rate of inflation. clearly, this hypothesis needs to be tested. if it were found to be valid, it would have implications for policymakers in a number of spheres, including monetary policy, prudential policy and even fiscal policy. systemic risk : interconnections and spillovers systemic risk is another theme of the conference, and again, a topic inspiring a great deal of academic research, some of which is being presented at this conference. systemic risk cannot be seen, nor can it be easily measured. so we need to explore a range of indicators. academic research is helping ensure that we are looking at the right ones. the aspect of systemic risk that i would like to highlight is the interconnections between banks, firms and countries that lie at the heart of the contagion that can turn a small disruption into something much bigger. in the global financial crisis, when one entity became distressed their counterparties incurred mark - to - market losses on the value of securities issued by that entity. investors also often started refusing to deal with those counterparties that had – or merely were thought to have – significant exposures to that entity. so, contagion could and did occur because of both direct and supposed interconnections. it can occur even as a reputational effect when two entities or economies are perceived to be similar : once investors have reassessed the risks in one institution or country, they often start to probe similar vulnerabilities elsewhere. we cannot escape the conclusion that greater interconnection is a prominent marker of increased systemic risk. the global policy response to the financial crisis has recognised the importance of interconnections and built that into the design of regulatory reforms. some of the design details are quite technical, but their essence is to create incentives against excessive interconnected exposures between banks, or between banks and other parts of the financial system such