anand sinha : financial regulatory reforms – not far enough or overkill opening remarks by mr anand sinha, deputy governor of the reserve bank of india, at the panel discussion on “ financial regulatory reforms – not far enough or overkill ” as part of the event “ global economic cooperation – views from g20 countries ”, organized by the indian council for research on international economic relations ( icrier ), new delhi, 7 – 9 october 2012. * * * a very good afternoon to you all. it is my privilege to chair the panel on “ financial regulatory reforms : not far enough or overkill? ” let me welcome the four very eminent panelists, mr jae - ha park, deputy dean adbi ; mr stephen pickford, associate fellow, chatham house ; mr paul bernd spahn, professor emeritus of goethe university, frankfurt am main, germany and ms susan thomas, assistant professor, indira gandhi institute of development research. the topic of the panel discussion is a subject of heated debate around the globe and i hope our discussions today would help set a balanced perspective on the issue involved. let me first try and flag the major issues and present both sides of the argument, without expressing my views at this stage. regulatory reforms undertaken as a policy response to the crisis have generated as serious a debate as the crisis itself. the crisis is still continuing and is unprecedented in terms of its coverage, impact and longevity. the policy response to the crisis, too, has been quite extensive and as some would say, onerous. going by the newton ’ s third law of motion ( every action has an equal and opposite reaction ), it is fair to expect that reaction ( policy response to the crisis ) matches action ( the crisis ), in magnitude. many, however, hold the view that this law has been violated inasmuch as the policy reaction is a case of overkill. the crisis has highlighted many gaps in the conceptual framework. some of the gaps are : the notion that macroeconomic stability ensures financial stability ; light touch regulation and supervision are adequate because financial markets are sophisticated and efficient, which can distribute risks to those who can handle these risks ; risk models measure risk accurately and all financial innovations are useful, etc. serious gaps have also emerged in macroeconomic modelling and, above all, in the understanding or lack of understanding of systemic risk and how to deal with it. the crisis has challenged the intellectual foundations of macroeconomic and financial policy making. new theories have been written debunk

in the belief that they will get their funds back as and when they want. this belief comes from the fact that it is a business that is licenced by a public authority that regulates and supervises the banks on certain established principles. the crisis highlighted inter alia the importance of regulating and supervising the liquidity risk management of banks thereby ensuring their safety and soundness under stressed conditions. any event that undermines this faith cuts at the very root of the relationship between a bank and its customer. depositors will withdraw money, borrowers will migrate to another bank which can meet their needs. thus poor liquidity risk management deals a body blow to a bank ’ s ability to undertake its basic business. in very simple terms, therefore, everyone transacts with a bank in the belief that it has the funds and funding sources to meet its obligations whether to a depositor or borrower. it may not be just meeting its liabilities but the credit needs of its borrowers as well. the depositor in a complex world could mean any person to whom the bank owes funds and the word borrower means any person to whom the bank has provided or committed to provide funds. liquidity risk arises when a bank is not able to meet its obligations without incurring a disproportionate cost and finally being unable to meet the obligations at all. the 2007 crisis revealed that well capitalised banks experienced difficulties which could be traced to lack of prudent liquidity management. it underscored the importance of liquidity to the proper functioning of financial markets and the banking sector. till then one believed that bis central bankers ’ speeches the wholesale market had unlimited capacity to fund the liquidity requirements of banks and thus led to funding risky or illiquid asset portfolios with potentially volatile short term liabilities. it showed through some cases how single institutions could cause deleterious systemic implications. basel committee responded by publishing principles for sound liquidity risk management and supervision, followed by two minimum standards for funding liquidity, viz., liquidity coverage ratio and net stable funding ratio. in 2012, the indian framework incorporated principles for sound liquidity risk management. these seventeen principles were issued so that the liquidity risk framework of our banks could incorporate the global best practices. in june 2014, rbi had issued the guidelines on basel iii framework on liquidity standards – lcr, liquidity risk monitoring tools and lcr disclosure standards, and in may 2015, draft guidelines on net stable funding ratio were issued