fail, one of the largest failures in new zealand ’ s history. another bank would have failed had its private sector shareholder not been in a position to inject very large amounts of additional capital, and even after that was done the institution was eventually wound up. at no point did it look likely that the whole banking system might fail, but we certainly had major problems with some of the largest participants in the system. what lessons did we learn from that experience? there were of course a whole host of factors which caused these difficulties. one important factor was the sheer inexperience of many of our bankers : they had been accustomed to a highly protected environment, and were ill - prepared to deal with the demands of a deregulated environment. nevertheless, i think there were four important lessons. while every country has to make judgements and decisions in the light of its own particular circumstances - and certainly no two countries are exactly alike - some of the things we learnt may have relevance to other countries also. lessons from new zealand : encourage banks to behave prudently first, it is important that banks are given every incentive to behave prudently. this may seem a self - evident statement, but it is astonishing how frequently the importance of this principle is ignored. in new zealand ’ s case, we diminished this incentive to behave prudently by allowing the view to go unchallenged that banks were effectively ‘ sovereign risk ’, or at least ‘ too big to fail ’. this meant that bank creditors felt little need to assess the creditworthiness of the banks with which they deposited funds - banks were, it was widely believed, effectively guaranteed by government. bank boards and managements may have felt similarly protected against the possibility of failure, and made loans with a disregard for risk which was, in some cases, breath - taking. this so - called ‘ moral hazard problem ’ may have been particularly severe in the case of two of the three institutions which got into serious difficulties in the late 1980s, both of them owned wholly or in part by government. there was little or no direction of their lending by government, but the management of both institutions certainly embarked upon lending transactions in the newly liberalised environment which rapidly got them into serious difficulties. in some asian countries, it is possible that the incentive for banks to behave prudently was seriously eroded not only by the impression that most large financial institutions would not be allowed to fail but also by the extent to which governments directed the lending activities of

currency board, as hong kong has done, and have the political and banking sector strength to endure the economic, political, and social pain which is inevitably associated with a currency board arrangement from time to time. in new zealand, we had a pegged exchange rate until march 1985. prior to that date, it was not uncommon for companies to borrow overseas, often at interest rates which were very much lower than those within the high inflation new zealand economy. some companies made rather spectacular losses when the new zealand dollar was devalued from time to time, or when, even when pegged, the new zealand dollar depreciated against the currency in which the loan was denominated. ( borrowing in swiss francs was particularly popular, and particularly painful, for some companies. ) but the losses were probably fairly moderate in comparison to the loss which the government itself incurred on behalf of taxpayers in 1984. in that year, the new zealand dollar was devalued by 20 per cent after a foreign exchange crisis which had certain similarities to some of those in asia more recently and the government, which had written very large volumes of forward exchange contracts with companies trying to protect their positions, incurred losses of many hundreds of millions of dollars. since march 1985, the new zealand dollar has been freely floating, and indeed i suspect we may be the only central bank that can claim not to have intervened directly in the foreign exchange market for more than 13 years. ( i say ‘ directly ’ because from time to time we did adjust monetary policy when we felt that movements in the exchange rate seemed likely to threaten our single goal of low inflation. ) one of the benefits of this has been that, though many companies and banks have borrowed overseas, none of this borrowing was undertaken in the belief that there was no currency risk involved. overseas interest rates were frequently much lower than those in new zealand, but after factoring in the exchange rate risk, the incentive to borrow offshore in foreign currency was substantially reduced. as a consequence, when, after a period of strong new zealand dollar appreciation between early 1993 and early 1997, the new zealand dollar fell by some 18 per cent against the us dollar, there were very few companies unhappy about that fall - and indeed plenty of exporters who were delighted. even fewer of our banks were caught out by the depreciation, and to the best of my knowledge none incurred losses as a consequence of the move. because they knew that the new zealand dollar was freely floating, they were