y v reddy : monetary and regulatory policies – how to get the balance with markets right remarks by dr y v reddy, governor of the reserve bank of india, as a panelist at the annual general meeting panel of the bank for international settlements, basel, 29 june 2008. * * * chairman jean - pierre roth, governor meirelles, distinguished economist bill white, fellow governors and friends. it was a treat to listen to edward lord george ’ s wonderful and erudite lecture on the “ approach to macroeconomic management – how it has evolved ” and sir andrew crockett ’ s comments, as chairman, on lord george ’ s per jacobsson lecture and also on lord george – “ steady eddie ” as he is warmly described. the reserve bank of india considers both of them as our special and lasting friends. i am also thankful for the opportunity provided to me to share my thoughts on monetary and regulatory policies. at the outset i would like to underscore that the critical word in the title is “ balance ”. so we have to recognize the links and interactions between the two, which may at times be reinforcing and at times be conflicting. in this balance, “ time - dimension ” is important. we know whether the balance is right or wrong only ex - post. for example, when there is all round prosperity, everyone wants everything to be left to the markets ; when things go wrong and there is pain, monetary and regulatory policies are invoked to save the situation. i will add that, in the balance to be maintained, public opinion is also important for the legitimacy and the effectiveness of monetary policy. public opinion goes beyond financial markets and institutions, but it is useful to remember that it includes government and media also. country - context is important because institutional factors of governance, state of the marketdevelopment, and values are relevant in the context of “ balance ”. hence, we cannot be judgmental about “ balance ” across countries, but we should assess the balance only in a country - specific context. i will present india ’ s experience in recent years as to how we are viewing “ balance ”, after recognizing all the above factors. first, on monetary policies, we monitor the monetary and credit aggregates. we use both liquidity and interest rate instruments. a dynamic balance is evident from the spread between the repo and reverse repo rates, which is enlarged during times of uncertainties. it has moved from 150 basis points to 100 basis points when

interesting because the level of competition is going to increase manifold, both for customers as well as for talent, transforming even the sleepiest areas in financial services. profitable because new technologies, information, and new techniques will open up vastly new business opportunities and customers. challenging because competition and novelty constitute a particularly volatile mix in terms of risk. in this talk, i will speak about how we see these aspects at the central bank. interesting and profitable over the next year, 17 new niche banks will begin business. in addition, licensing for universal banks is now on tap, so fit and proper applicants with innovative business plans and good track records will enter. fintech will throw up a variety of new ways of accessing the customer and serving her, so new institutions that we have little awareness of today will soon be a source of competition. these will finally draw customer sectors, firms, and individuals without access today into the formal financial system. those customers that are already being served will be spoiled for choice. bis central bankers ’ speeches for the service provider, even though greater competition will tend to reduce spreads, access to new customers and new needs will increase volumes. moreover, risk - and cost reduction through information technology and risk management techniques will tend to increase effective risk - adjusted spreads. in sum then, despite increased competition, profitability can increase. the comparative advantage of banks may lie in their access to lower cost deposit financing, the data they have on customers, the reach of their network, their ability to manage and warehouse risks, and their ability to access liquidity from the central bank. these should then be the basis for the products they focus on. perhaps a couple of examples may be useful. india will have enormous project financing needs in the coming days. even though bankers are very risk averse today, and few projects are coming up for financing, this will change soon. what is in the pipeline is truly enormous – airports, railway lines, power plants, roads, manufacturing plants, etc. bankers will remember the period of irrational exuberance in 2007 - 2008 when they lent without asking too many questions. i am hopeful that this time will be different. here are ways it can be different and risks lowered. first, significantly more in - house expertise can be brought to project evaluation, including understanding demand projections for the project ’ s output, likely competition, and the expertise and reliability of the promoter. bankers will have to develop industry knowledge in key areas since consultants can be biased. second, real risks have