Dr Reddy also underscored the need for developing a market-oriented financial system while maintaining the independence and credibility of the regulator. He touched upon the issue of single regulator and argued against separating banking supervision from the central bank.
The issues relating to cross-border supervision of financial intermediaries in the context of greater capital flows are just emerging and these need to be addressed, Dr Reddy said in his address at Zurich University in Switzerland. Dr Reddy viewed the volatility in capital flows as a trend in the emerging economies.
Capital flows at critical times reflect more of changes in the risk appetite of the international investors than a countrys fundamentals, the governor said, adding, many emerging market economies do not seem to have adequate self-correcting market mechanisms in respect of such cross-border capital flows.
Therefore, special defences need to be put in place for ensuring financial stability in countries like India that are faced with the prospect of volatile capital flows, according to the copy of his speech released by RBI on Tuesday.
The major sources of such shocks in India are very sharp rise in oil prices and extraordinary monsoon failures. The governor observed that in India, political cycles have had a relatively muted impact on financial stability. Regarding the move from a government-dominated financial system to a market-oriented one, Dr reddy said: Enhancing efficiency while at the same time avoiding instability in the system has been the challenge for the regulators in India.