Growing economy to boost India’s banking system: RBI

Font Size

Print

Feedback

Email

Discuss

Related Articles

HDFC Bank cuts rates for used carsUnion Bank starts auditing branchesPvt banks pip public peers in NPAsBanks likely to retain home loan rates

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.

In a liberalised environment, banks’ own exposures to exchange rate risk, coupled with their exposures to corporates which are exposed to similar risks, spanning across national jurisdictions, add to the multiplicity of risks which also raise the issue of close monitoring and prudential management. A strong banking sector in a fuller capital account regime, is also important for implementing an appropriate monetary policy. In particular, exchange rate risks and spill-over effects across markets are specific challenges to be dealt with in a globalised scenario. Inability to meet these challenges might translate into instability in the financial system. In a freer capital transactions regime, the magnitude of money laundering might also scale up along with the overall increase in financial flows, requiring appropriate policy responses of the financial system.

On regulation for ‘Financial Conglomerate’' RBI has said traditionally, the regulation of financial intermediaries all over the world has been on institutional lines, whereby regulation is directed at financial institutions, irrespective of the mix of business undertaken. In recent years, distinctions between banks and nonbanks financial intermediaries have become blurred. A number of financial conglomerates have also emerged that undertake various financial activities under the same corporate structure. These have challenged institution-based regulation as it fails to take into account the gaps and overlaps in regulation. Moreover, the risk assumed by the financial conglomerates as a group may be higher than the sum total of risks assumed by its affiliates/subsidiaries undertaking a number of activities.

Therefore, the regulatory structure based on institutions has become a major issue of policy and public debate in several countries. In order to overcome the issues raised by operations of financial conglomerates, some countries have followed a system of super/single regulator, which oversees all segments.

Some other countries have followed objectives-based regulation under which regulation is directed based on the objective (prudential regulation or market conduct).

However, each of the structures has its own advantages and disadvantages and the regulators are grappling with the issue as to which is the most appropriate structure. The recent financial market developments and the failure of Northern Rock in the UK, which had a supervisory structure outside the central bank, have added more uncertainty to this issue.