the exchange than do buyers ( lenders ). faced with such an asymmetry, buyers will be cautious, and will tend to over - estimate ( price ) risk. if risk is over - priced, this may drive out the less - risky activities, causing buyers ( lenders ) to become more cautious still. such a process can result in less exchange than would otherwise be the case if the two sides to the exchange were more equally informed. hence, an important purpose of financial regulation is to address this information gap. the regulation may include insisting on a greater level of disclosure, or imposing certain standards on sellers ( borrowers ). financial regulation, like many other forms of regulation, thus generally entails a combination of disclosure requirements and standard setting. the existence of externalities and ‘ free - rider ’ opportunities in some instances also means that risks may not be borne by the owner of the asset, and hence not priced or managed adequately. a result can be that under - investment in some risk management tasks may occur, such as, for example, ensuring the ongoing operational capacity of critical payment systems in a systemically important financial institution. structural factors can mean that identifying, pricing, allocating, and managing financial risks can be very difficult at times, if not impossible, thus necessitating various forms of prudential regulation, financial crisis management capabilities, and / or the public provision of certain financial services. for example, it is difficult to be able to identify all threats to financial stability ex ante. hence, some forms of risk are best managed by ensuring adequate capital buffers are in place to absorb losses without disruption to the system. the basel ii process of allocating capital buffers to various forms of financial risks in banks is an example of such an intervention. some forms of risk are also not adequately priced due to the lack of a market for the price discovery process to occur. likewise, both free - rider and externality aspects of certain payment system networks may mean that risks are not allocated accordingly and may be mismanaged. this may necessitate the public provision of certain services ( e. g. utility networks ) or prepositioned loss allocation mechanisms in the case of a bank failure. behavioural stresses the financial system can also be exposed to destabilising behaviours. these influences can be exacerbated by some of the structural weaknesses discussed already, especially for example, the phenomenon of contagious bank runs. recent developments in the field of behavioural

policy action recent policy developments over the past few years we have “ re - invigorated ” the bank's own financial stability role. this has been reflected in a number of ways. in november 2004, we commenced publishing a twice - yearly financial stability report, as a complement to our quarterly monetary policy statements. we have also introduced a local incorporation and an out - sourcing policy for registered banks. the former requires large banks to be incorporated in new zealand, rather than operate as a branch of a foreign bank ( as has been the case with westpac ). the latter requires banks to manage out - sourcing of core banking functions in a way that does not compromise their ability to maintain a core operational capability should a service provider become unable or unwilling to provide those functions. the local incorporation and outsourcing policies have been introduced mainly to improve the resilience of the new zealand banking system in a bank failure situation. that is a situation that we all hope falls into the " rare event " category, though we know from experience that bank failures can and do happen. and we know that there is a tendency for rare events to slip into the background, and in the case of those that could be very damaging, perhaps more than they should. one of the jobs of the reserve bank is to act as a counter to such tendencies. in parallel with progressing these issues, which affect mainly the large australian - owned banks, steps have been taken to strengthen the harmonisation and co - ordination of trans - tasman banking supervision. last year, the trans - tasman council on banking supervision was established, with a terms of reference which cover supervisory co - operation, preparedness for responding to crises that involve banks that are common to both countries, and whether legislative changes may be required to ensure apra and the rbnz support each other in their regulatory responsibilities, at least regulatory cost. the council recommended some legislative changes, for enactment in both australia and new zealand. dr cullen and the australian treasurer announced following their annual meeting that both governments will be promoting those legislative amendments. currently we are also involved in the government contingency planning for a possible influenza pandemic. besides making contingency plans to maintain our own operations, we have been working with the banks to ensure that business continuity planning is in place, and that key payments systems and cash distribution arrangements could be adequately maintained in the unlikely event that an influenza pandemic would impact on staff availability. we have been consulting with banks