spillovers. this opacity magnified the shock to confidence as the recent crisis unfolded. – the financial system has a propensity to become over - leveraged and heavily interconnected, leading to massive deleveraging and easily available propagation channels, both domestically and globally. – liquidity risks, both the funding risks incurred by institutions and the associated market liquidity risks of assets, are often much higher than recognized. – financial intermediation has increasingly shifted to the non - or less - regulated “ shadow ” banking sector, in large part to avoid the more stringent requirements imposed on banks. – there is a critical absence of effective mechanisms to deal with institutions that were deemed “ too big to fail. ” how do regulators meet the above challenges? 21. central banks must take a long - term view of the economy and craft appropriate policy responses. we must have the latitude to raise interest rates when others want cheap credit and rein in risky financial practices when others want easy profits. there has to be greater societal consensus on taking tough corrective actions. 22. while progress on macro and micro - prudential regulations will be the key for moving forward, some work is still needed from the regulators in providing guidance to the market in instituting a mechanism in the area of managing not only several “ known unknowns ” but also a number of “ unknown unknowns. ” 23. with the benefit of hindsight, low nominal interest rates, abundant liquidity and a favorable macroeconomic environment encouraged the private sector to take on everincreasing risks. financial institutions provided loans with inadequate checks on borrowers ’ ability to pay and developed new and highly complex financial products in an attempt to extract ever higher returns. meanwhile, many financial regulators and supervisors were lulled into complacency and did not respond to the building up of vulnerabilities. we have to develop more sensitivity in our policy tools to capture and quickly correct our policy stance to control such covert signs of overheating. conclusion 24. in summing up, i would like to reiterate that though each one of the key challenges facing the indian financial system begins with the banking system, it does not and should not bis central bankers ’ speeches stop at the banking system. banks have to look beyond the way banking is traditionally defined in a narrow fashion ; they need to look towards the vulnerable and other excluded sections of the population as bankable. stakeholders other than banking too need to involve themselves in the process of expanding

be fully convergent with ifrss with effect from april 1, 2011. reserve bank of india is actively working with the government, accounting standard bodies and banks for ensuring preparedness for smooth convergence by the banking system. way forward the agenda that is being developed for strengthening of financial sector regulation and supervision is ambitious. contentious issues will arise both at national and at the international levels on regulatory cooperation. whereas the principles underlying this regulatory overhaul are being increasingly accepted, many challenges will arise on their practicality and modes of implementation : • firstly, there is a need to ensure that regulators and supervisors remain firm in their resolve to ensure that there is no build - up of risk in the system and that the principles and framework articulated are adhered to in letter and spirit. • second, the interconnectedness of the institutions and markets requires central banks, banking and securities regulators to work in close coordination with full exchange of information and frequent interaction to assess the systemic risks at any point of time. • third, several of the countercyclical proposals are dependent on the assessment of economic and banking conditions in national jurisdictions which will determine the capital buffer requirements – these will obviously vary from one jurisdiction to another as cycles would also vary. with banks operating across the globe, this will imply that capital requirement could vary across jurisdiction – parking the transaction in a more favourable jurisdiction cannot be ruled out. coupled with complex structures and differential tax regimes, minimising regulatory and tax arbitrage will continue to be a huge challenge. • fourth, cross border resolution issues will continue to be daunting especially as national regulators will seek to protect domestic depositors and stake holders. • fifth, convergence toward international accounting standards will be a huge challenge in terms of not only bringing in the changes in standards that are appropriate for the country but also for putting in place systems and capabilities to facilitate convergence. issues such as putting in place prudential filters for not distributing unrealised gains would also arise. • sixth, while there are discernible signs of recovery in the global financial markets, the real test of the resilience of the financial system will be its performance through the exit process. for the emerging market economies such as ours, the challenge will be to manage the impact of this process of global stabilisation. • seventh, in emerging markets such as india, without sufficient historical data of credit and default cycles, there are difficulties in putting in place many of the advanced methodologies under the regulatory framework such as expected loss provision