glenn stevens : asia, australia and financial markets1 address by mr glenn stevens, governor of the reserve bank of australia, to the asia society australasia centre ceo asia update luncheon, sydney, 18 september 2007. * * * as you would all be aware, 2007 is the 10th anniversary of the asian financial crisis. the crisis is usually dated as having begun with the float of the thai baht in july 1997, though the problems had been building for some time before that. the events of 1997 and 1998 profoundly affected the region ’ s economic growth. in a speech earlier this year, i reviewed the key events of the crisis. 2 rather than go over that ground again today in detail, i will address the question of how asia is coping with the recent distinct change in global financial market conditions, before talking about how the same events are affecting australia. i want, then, to turn to issues for the future and, in particular, what interests the asia - pacific region has in the ongoing efforts to renovate the post - war official architecture of the international financial system. recent financial events for a number of years now, many commentators have expressed concerns about the under pricing of risk in financial markets, with investors increasingly willing to purchase risky assets at high prices and often with considerable leverage. easy credit conditions accommodated and encouraged these trends. over the past couple of months, we have witnessed something of a reversal. the initial trigger was the deterioration in the us sub - prime mortgage sector, itself a result of declining credit standards and a slowing us housing market. since the exposures to these risks had been spread via securitisation into global financial markets, losses are being borne in most parts of the world, including in australia and some countries in asia. those losses have been coming to light only slowly, however, in part because the complex and opaque nature of some of the financial instruments in use makes valuation difficult, or even impossible under adverse conditions. in some cases, there simply is no market for, and hence no way of providing an objective valuation of, the claims in question. in the ensuing climate of uncertainty, investors rapidly have become quite risk averse, and some parts of the global capital market have suffered severe dislocation. in turn, institutions that rely heavily on wholesale capital markets, either for balance sheet funding or to securitise assets they have originated, have experienced difficulties. so - called conduits, credit arbitrage funds and various other vehicles often issued short -

have been known to move. it should go without saying that loan rates are decided by the intermediaries making the loans on the basis of their costs, risk assessments and competitive considerations. the rba does not set these rates, though we can and do take account of how the margin between these rates and the cash rate alters. as markets work to re - price risk and individual participants grapple with uncertainty about their own possible future liquidity needs, lending and borrowing have been kept very short term. the rba has acted to assist market functioning by extending the pool of acceptable securities for repurchase agreements. the intention of this is to give market players some additional confidence that quality assets can be turned into cash if needed, so they can get on with the job of re - pricing risk. from our point of view, this means accepting a little more private credit risk in our operations, but we have been moving in that direction anyway for years, if for no other reason than that there is no longer a sufficiently large stock of government securities on issue in which we and market participants could transact in volume. provided the transactions are conducted on proper commercial terms with appropriate margins, we judge these credit risks to be manageable. helping financial markets to function as they undergo a re - pricing is, of course, one role of a central bank. but it is also important that we do not lose sight of our other role, of making monetary policy in pursuit of sustainable growth with price stability. from that perspective, we observe that funding costs for intermediaries have risen beyond the adjustments associated with the rise in the cash rate on 8 august. some borrowers are being asked to recognise this higher cost in the rates they pay for their loans, a trend that will continue if the higher funding costs persist. hence it appears, at this stage at least, that we may well observe a further tightening of financial conditions in the australian economy in the months ahead. in assessing that prospect, the bank will need to take note of two forces. the first is that, going into this episode, the economy was travelling very strongly, with the outlook for growth and inflation being revised higher over recent months. the data since the august decision to lift the cash rate indicate an economy at least as strong as the board ’ s assessment at that time, with few signs of that momentum slowing. the second factor is that the outlook for the us economy has been weakening and will presumably be affected to some extent by the credit market