Growing economy to boost India’s banking system: RBI

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Mumbai, Sep 4: Raising the issue of capital convertibility, the Reserve Bank of India, in its report on currency and finance 2006-08, has said that as the economy gets increasingly integrated with the global economy, the Indian banking system would also get progressively integrated with the rest of the world.

The Committee on Fuller Capital Account Convertibility (Chairman SS Tarapore), which submitted its report in July 2006 had, inter alia, recommended a broad timeframe of a five-year period, to be implemented in three phases for a fuller capital account convertibility, viz, 2006- 07 (Phase I), 2007-08 and 2008-09 (Phase II) and 2009-10 and 2010-11 (Phase III).

A further liberalisation of capital account transactions is expected to result in a larger two-way flows of capital in and out of the country. In a regime of fuller capital account convertibility, banks will be expected to undertake transactions in multiple currencies, acting as channels for the flow of funds in and out of the country when they are enabled to receive deposits and raise borrowing from both residents and non-residents and lend and invest in both domestic and foreign jurisdictions.

Likewise, non-resident banks and financial institutions are expected to undertake similar transactions. The non-financial entities having links with the banking system would also conduct transactions in multiple currencies when they borrow lend and invest overseas.

All these types of transactions add to the risks of the banking system that are not so evident in a less open domestic banking system. Thus, the banking system in a freer capital account regime would be exposed to enhanced risks in terms of currency risk, counterparty credit risk, transfer risk, legal risk, risk of regulatory arbitrage, risk in derivatives transactions and reputation risk.

This underscores the need for risk management capabilities in the banking system. Freer capital regime would also require improvement in the liquidity management and disclosure practices by financial institutions as they would be encouraged to diversify funding sources to contain maturity mismatches and improve debt-equity mix.