. real estate, so to say, had crossed the rubicon to emerge as a true investment asset. ( iv ) there was increasing anecdotal evidence of the inventory buildups of completed commercial as well as residential units. these were clearly signs of real estate having crossed the basic demand - supply equation to an investment asset. ( v ) there was a visible steep increase in land prices coming from auction results. large real estate companies could monetise the huge land banks on the back of the then booming stock market valuations with a simultaneous increase in bank lending for commercial real estate. 15. it was in the above backdrop that it was decided to make it costlier for banks to finance loans backed by real estate. it was felt that the usual sector - neutral monetary policy instruments would not be effective without posing significant costs to the economy generally. so while the monetary policy instruments were indeed used, the objective of this generalised, gradual tightening was quite different from the requisite stronger action in respect of bank exposures to sectors such as real estate. 16. it needs to be appreciated that in the indian context, the sharp rise in bank credit to the real estate was per se not a clear indicator of any asset price bubble given the inherent demand - supply dynamics in the economy and the genuine needs of an economy on a high growth path. there was a confluence of positive factors contributing to the development including a decline in inflation and stable inflationary expectations, resulting in decline in both nominal and real interest rates and availability of ample systemic liquidity, contributed no less by the rising tide of capital flows. concomitantly, there was a shift in funding by the corporates to non - bank sources, including external borrowing, which forced banks to look at diversifying their lending portfolios. this shift also helped in meeting the increasing genuine demands on the commercial real estate front, including the office space largely accounted for by the it boom and gradual expansion of organised retail to tier ii cities. 17. the objective, i must underline, was not to address the asset price bubble per se and not to curtail genuine credit needs of the economy but to prepare the banking sector to better manage the potential downsides related to selective sectors. in other words we adopted what is now called the “ expected ” as well as “ unexpected ” loss approaches. 18. what are the key inferences? first, that harmonisation of the monetary policy objectives and prudential objectives can give a more complete picture, which

exposures dynamically. ( iii ) to attempt pre - empting asset price bubbles in the economy and limit the build - up of financial risks in the system. asset price booms have invariably been identified with a pre - crisis economic configuration as both symptomic as well as causative factors. earlier, though, the policy frameworks adopted an approach of benign neglect of asset prices as they saw little role either for the monetary policy or prudential policy in addressing these. the recent crisis however has forced a rethink in this regard. there is now a broad consensus on the need to use credit channel as a macroprudential instrument. 6. the group of governors and heads of supervision ( gohs ), the oversight body of the bcbs have recently announced 1 broad agreement on the overall design of the capital and liquidity reform package, though much of the work in regard to countercyclical buffers and forward looking provisions is still work in progress. bis press release, the group of governors and heads of supervision reach broad agreement on basel committee capital and liquidity reform package, july 26, 2010. 7. the recent bcbs consultative document 2 lays out a broad framework in regard to countercyclical capital buffers, conceptually based on deviation of credit to gdp ratio from its long term trend. recognising the different contexts in each jurisdiction, each national supervisory is expected to apply judgment in the setting of the buffer after using the best information available to gauge the build - up of system - wide risk. however, it does not envisage addressing sectoral credit issues through such countercyclical measures. 8. the challenge, particularly in growing emerging market economies, would be to reconcile this approach with the risk of credit constraints given the supply side issues which are qualitatively very different from advanced economies. generalized credit increase higher than the trend may not, in itself, be a matter of systemic concern in view of the changing structure of economies. the framework in these countries would therefore necessarily have to adopt a more nuanced, sectoral focus. there are challenges in trying to influence asset prices through the credit channel. first, it is really difficult to set an optimum level of asset prices as a target. second, only bank financed exposures to asset markets can be influenced through macro prudential tools which may not generally be the dominant funding source. there have been instances where asset prices build - up is due to leverage outside