"We have seen a significant reappraisal of certain categories of risk and considerable financial turbulence in key international markets," said Stevens. "Economic prospects in the United States, in particular, have taken a significant turn for the worse," he added. "The extent of disengagement in some core markets, which hitherto had been thought to be extremely liquid and reliable, has been quite unsettling."
Still, Stevens emphasized that the Australian banking system was weathering the storm well, with profitability very strong and little direct exposure to the U.S. subprime problems.
He noted that banks were still able to raise funds.
"The Reserve Bank has been carefully monitoring access to funding, including offshore funding," said Stevens. "We judge it to have been more than adequate, even if more expensive, though, of course, we will continue to watch the situation closely."
Many commercial banks have passed on the higher funding costs by raising rates for mortgages and corporate debt, independent of tightening by the central bank.
Stevens said the RBA had taken this trend into account when setting monetary policy, but made no mention of the outlook for domestic interest rates or the economy. The central bank has raised its key cash rate three times since August in an effort to contain inflation.
Indeed, Stevens noted that some central banks around the world were having to balance the necessary provision of liquidity to financial markets at a time when they were also confronted with a troubling level of inflation.
Stevens noted the U.S. Federal Reserve had taken the most aggressive steps so far by taking assets from troubled investment bank Bear Stearns onto its own balance sheet.
"This is, however, not a 'bail out' - the shareholders and managers of Bear Stearns have lost a great deal of money, but the system will be stabilized," said Stevens.
Stevens warned that central banks would have to be wary that financial firms did not come to count on state aid and "become so confident that liquidity risk has effectively been removed that they end up taking more risk of other types."
"That could leave both themselves and their central banks in an awkward position at some point down the track," said Stevens. "There will need to be a focus in the supervisory community and the banks themselves on liquidity management."
Stevens noted that cash was still flowing into pension funds, insurance companies and the like and would need to be invested at some point.
"Increasingly, there are good quality assets at prices that would, in normal times, be very attractive," said Stevens. "At some point, investors who are currently on the sidelines will need to summon enough confidence to take up the opportunities for profitable exposure to risk."
For this to happen, investors would want a reasonable level of confidence that the bulk of the losses in the most important institutions have been accounted for, that remaining 'excess' leverage has been sorted out, and that any downside risks to asset quality stemming from slowing growth in the major countries were manageable.