into question. we cannot go backwards to revive the two bargains – that means reversing development and bottling the genie of competition, neither of which would be desirable for the economy even if feasible. instead, the best approach may be to develop the financial sector by bis central bankers ’ speeches increasing competition and variety, even while giving banks, especially public sector banks, a greater ability to compete. let me be more specific. increasing competition in banking the reserve bank of india is committed to freeing entry in banking. we just announced two new commercial bank licenses after a rigorous vetting process. we are examining this experience, and after making appropriate changes, will announce a more regular process of giving licenses – what has been termed licenses on tap. because of the public ’ s trust in banks and the presence of universal deposit insurance, we have to be careful in giving out the normal commercial bank licenses. to be absolutely confident of the capabilities and integrity of applicants, we give licenses only to those who have a proven track record and reasonable capital. but what of those who have no track record or no large fund base but do have capabilities? and what of those who see synergies in doing only one part of the banking business such as payments? the rbi can take more of a chance with new players if they get the license to open only a small bank or to conduct only one segment of banking business. such differentiated licenses – licenses with restrictions on the geographical reach or the products offered by a new bank – can generate more organizational variety and efficiency. small banks tend to be better at catering to local needs, including needs of small and medium businesses. a payments bank, which will take deposits and offer payment and remittance services but be constrained to invest all its funds in safe instruments such as government securities, could be very synergistic with other existing services. for example, the proposed post bank could start as a payment bank, making use of post office outlets to raise deposits and make payments. key in any new structure is that there should be no arbitrage possibilities hurting the current banking system. today, a commercial bank can convert itself into a payment bank by maintaining 100 percent slr margins. of course, it may not want to, because it seeks to make more money through corporate lending, but this possibility indicates regulations will not favour a payments bank unduly. some of my colleagues believe a payments bank will be unviable, while others believe that it will skim the cream of

. meanwhile investment banks took the mbas off their balance sheets so that they could leverage once more and repeat the cycle of sub - prime lending. at one level, it is possible to argue that nobody in the entire chain did anything legally wrong. but that is too simplistic an argument. we do not govern our behaviour simply by what is allowed by law or regulation. our code of conduct should be held to a stricter test. was the behaviour of actors across the chain of the financial sector fair, ethical and moral or was it swayed by the opportunity of making quick profit afforded by information asymmetries? were sub - prime borrowers adequately warned that there is a good chance that asset prices would fall? did investment advisers tell their clients of the risk they were taking in buying mbas and cdos? did credit rating agencies not compromise their standards and cut corners? in sum, were professionals in the financial sector legally right, but only legally right and morally wrong? the crisis has also exposed an issue of moral hazard in the banking system – something that has come to be called privatization of profit and socialization of costs. banks enjoy an implicit guarantee of government bail out. this is true regardless of whether a large segment of the banking sector is owned by the government as in our country, or whether the banks are privately owned as is the case in most countries. governments, regardless of their political affiliations, can hardly afford to have large institutions fail. this “ too big to fail ” syndrome enables financial institutions to take risks that, say a soap manufacturer, cannot take. if as a result banks make huge profits, they can reward themselves with generous pay packets and bonuses. and if loans sour and the balance sheets crash, no worry since the bank will be bailed out at tax payers expense. the difference between the financial sector and other businesses is therefore quite clear. if say, a soap manufacturing company is an astounding success, who benefits? the shareholders and the management. and if it fails, who loses? both of the above. but in the case of a bank, the story is different. if the bank is a success, who benefits? the shareholders and the management. and if it fails, who loses? not the shareholders and the management, but the public at whose expense the bank is bailed out. the ripple effect is less pronounced but similar in the case of all institutions in the financial sector even if they are not banks. that crucial difference, i