of the next crisis in good time. this means that, in future, institutions will also have to be prepared for hitherto unknown dangers, uncertainties we may not even know exist. and here, a strong capital position is the best buffer against shocks, regardless of where they come from. however, dealing with unknown dangers requires german banks to embrace a new risk culture. the crisis made us painfully aware of just how far removed from a sound culture of risk the risk culture was at many banks in germany. 2. risk culture one reason for an inadequate risk culture lies in the “ too big to fail ” problem, which was a central issue in the last crisis. the failure of banks that are very large or strongly interconnected might endanger the whole financial system – the failure of lehman brothers in 2008 was a case in point. thus, in the eyes of the markets these banks enjoy an implicit bis central bankers ’ speeches state guarantee : in case of trouble, the state would feel compelled to step in and rescue the distressed bank. yet this implicit state guarantee creates flawed – and dangerous – incentives. if a bank can be sure of state support when it gets into difficulties, it will no longer see risk and return as being two sides of the same coin. essentially, this means that profits from risky business operations remain with the bank, while the taxpayer is left to shoulder potential losses : this is an unjustifiable scenario. for this reason, i believe that an important signal to the market and to banks is to develop mechanisms that allow even big banks to fail without destabilising the entire financial system. the possibility of a market exit, which is fundamental to any market economy, must also exist for the banking sector. the real threat of actually failing is in itself a strong incentive for banks to be more aware of risk in their actions. the long - term goal, then, must be to put risk and return back onto the same page. one important step towards that goal is the european resolution mechanism which will start in 2016. this mechanism ensures that the owners and creditors of banks are the first in line when it comes to bearing losses. consequently, the taxpayer will be the last in line to foot the bill. this realigns risks and rewards and will certainly have a fundamental and positive effect on the risk culture within banks. yet what is crucial here is not only that rules are in place for dealing with a distressed bank, but that banks don ’ t get into financial dire straits in

##a liaison imported - 50 domestic % - 50 % unit labour costs non - farm, year - ended growth - 10 * r e s e r v e b a n k o f au s t r a l i a - 10 share of firms reporting above - average increases less share reporting decreases, no change or below - average increases ; average increase indexed to 0 ; smoothed with a 13 - month henderson trend. sources : abs ; rba. survey measures, including in the rba ’ s liaison program, suggest that firms are continuing to pass through some of this cost growth to prices, although softer consumer demand has made pass - through more difficult in some industries. the key takeaway here is that domestic capacity pressures, in both housing and market services, are contributing to above - target inflation. despite a gradual easing over the past 18 months, the labour market remains relatively tight, with labour availability still a constraint for some businesses and job vacancies elevated. we also continue to observe tightness across product markets, and firms report high capacity utilisation. restrictive monetary policy has been working to bring demand and supply more into balance and this has contributed to the easing in aggregate cpi inflation. it is true that inflation in some components of the cpi has eased more than others. but it is not unusual for different components of inflation to behave differently at any point in time. and at an aggregate level, there is further to go. with underlying inflation having fallen very little over the past year in quarterly terms, the board is vigilant to upside risks. that is why, as the board has said, policy will need to be sufficiently restrictive until we are confident that inflation is moving sustainably towards the target range. why is bringing inflation down so important? we know the restrictive monetary policy settings that are necessary to bring inflation down are causing hardship to some households and businesses. we are very conscious of that. in fact, we spend a lot of time trying to understand how interest rates settings are affecting households and businesses – and i will say more about that later. but inflation causes hardship too, for all australians and particularly for the more vulnerable in our community. our experience of how costly inflation can be is the reason that getting inflation back to the target range is our priority. there are two ways to come at this. the first, taking a longer view, is to remind ourselves why we have a flexible inflation targeting framework, which goes back to the experience with high inflation in the 1970s and 1980s.