Meanwhile, smaller foreign banks are expected to develop new strategies to grow, and to increase participation in the domestic economic activity through expansion of the necessary skills and product development thereby enhancing their value addition in the economy. Non-bank financial institution sector One of the objectives of the consolidation plan is to fashion out an NBFI sector that comprises of a smaller number of strong NBFIs, which are fully compliant with the Central Bank’s regulatory framework. On completion of the consolidation, we expect about 20 standalone NBFIs, of which at least 3 would specialise in microfinance business, and each NBFI would own an asset base of over Rs. 20 billion by 2016. Although there has been some criticism that this would lead to an oligopolistic market where lending rates would be high while deposit rates would be low, the post consolidation NBFI sector with the increased quality and quantity of capital is expected to have improved loss absorbency capabilities and enhanced resilience to internal and external shocks, and with such improvements, these NBFIs will be able to attract low cost, long term funds from the market in the form of deposits and debt. Further, in order to be competitive, NBFIs have to improve cost efficiencies, diversify their businesses, be ready to deal with market volatilities, and be able to manage risks in an integrated manner. Finally, following the consolidation, NBFIs are expected to have improved governance and fit and proper management teams capable of running the entities efficiently and competitively.

BIS Review 35/2002  1  This sequence affects different categories of assets (commercial property, residential property, equity), whose impact on the real economy and transmission channels differ. Commercial property seems particularly linked to the business cycle, while residential property has a larger impact on consumption. Equity prices are intertwined with business profits and investment but are also related to spending through wealth effects, depending on the role equity plays in the determination of financial wealth. This interaction between credit cycles and asset price bubbles poses a number of challenges for the authorities and regulators, both in the monetary policy and financial stability domains. In the upswing, inflationary pressures related to excessive credit growth are compounded by financial imbalances resulting from unwarranted optimism on the part of corporations and households and excessive risktaking on the part of financial institutions. In the downturn, recessionary and deflationary forces are aggravated by credit contraction as a result of excessive risk aversion by lenders. The possible explanatory factors of this potential amplification of the cycle in the financial sector are many-faceted and complex. First, heightened competition in the banking sector and in financial markets leads in an upturn to riskier strategies that are only corrected when the rise in bad debts becomes evident in the downturn. Second, there seems to be a tendency for economic agents to overreact to changes in their environment, leading to over-optimism in times of plenty and over-pessimism in bad times. Third, herding usually reinforces existing trends and causes overshooting.