with the process of financial deregulation that has taken place in the asian countries over the last 10 years or so is that it was driven partly by doctrine. this doctrinal imperative reflected two separate forces, which came together more or less by accident. the first of these forces was the dominance in academic circles of the “ efficient markets paradigm ”. this is a powerful analytical device, which has taken thinking in economics down very useful directions. but it, like all paradigms, is an imperfect representation of the real world. perhaps more seriously, in the course of academic debate, it became quasi - religious, with beliefs and facts becoming confounded. this made it hard to leaven the efficient markets paradigm with some real - world facts – principally, that markets are imperfect. the second force was a simple commercial imperative on the part of foreign financial institutions to gain access to new markets and compete in the most vigorous way. this commercial imperative was successfully transplanted into the political processes, so we saw, for example, the oecd insisting on capital market deregulation as a condition of korea ’ s membership of the organisation. these forces combined to form powerful rhetorical pressures, to deregulate as fully as possible, with special virtue being attached to those who opened their markets at the most breakneck speed. one of the notable manifestations of this was the bangkok international banking facility, whereby small thai businesses were presented with a frictionless conduit to international financial markets, where they could borrow at attractively low interest rates, in foreign currency. in australia, we know, from our small taste of the swiss loans in the 1980s, how dangerous it is to have relatively unsophisticated borrowers given the opportunity and incentives to take on sophisticated products involving foreign exchange risk. but in australia this was relatively modest in macro - economic terms. in thailand, the inflow through the bangkok international banking facility was not far short of 10 % of gdp. with this change of attitude, it should be easier to insert some common sense into the process of deregulation, and have the courage to say “ no ” ( or “ not yet ” ) to some aspects of deregulation which seem to make countries more vulnerable. so it may be quite sensible, from this viewpoint, to put various restrictions on short - term capital inflows, and on foreign - currency borrowing. this is compatible with free - market principles, because these are properly seen as transition measures, to be modified and

don ’ t amount to a return to pre - crisis conditions. loan impairment rates are still high and property markets in the us and europe are still weak, and these things have contributed to some ongoing nervousness in global credit markets. in addition to all that there is a particular focus at present on sovereign debt. a number of countries are running with very high levels of government debt in relation to their gdp and large fiscal deficits ; and there is obviously considerable focus on the sustainability of those positions and the risk of default. i ’ m not going to make any predictions as to how that might evolve, partly because the situation is subject to ongoing change and policymakers in the various countries are still developing their responses. but i would make two points regarding potential implications for australia : first, the australian banks have only limited direct exposures to sovereign debt in the countries regarded as being most at risk. so potential effects on australian banks ’ overall asset quality are not an issue. a second channel of possible effect would be if there were some generalised disruption in global wholesale funding markets. here it is important to note that, in the post - crisis environment, the australian banks have significantly strengthened their positions. they have increased their reliance on domestic deposit funding, lengthened the average term of their wholesale funding, and correspondingly reduced their reliance on short - term wholesale debt. these changes will help to bis central bankers ’ speeches make them more resilient to any disruptive event in international credit markets, should it occur. let me make a few more general remarks about the australian financial system in the current environment. i ’ ve already made the point that australian banks came through the crisis in good shape. bank profits did decline during the downturn but they have since recovered, largely as a result of declining loan loss charges. arrears rates in some areas have continued to creep up, but asset quality generally remains good ( especially by international standards ). despite the uncertainties about europe that i ’ ve already referred to, conditions in funding markets for the australian banks have improved since the crisis, and so has system - wide growth in deposit funding. domestic securitisation markets have been recovering. these developments have helped smaller lenders to regain some of the market share lost during the crisis period. aggregate lending by banks has been relatively subdued in the past few years. lending to the housing sector has continued to expand, but at a slow pace, while business lending has tended to fall, with businesses relying more on internal