been encouraging banks to formalize their capital adequacy assessment process ( caap ) in alignment with their business plans and performance budgeting systems. this, together with the adoption of rbs, would enable factoring in of the pillar ii requirements under basel ii. fourth, we have been expanding the area of disclosures ( pillar iii ), so as to have greater transparency in the financial position and risk profile of banks. finally, we are trying to build capacity for ensuring the regulator ’ s ability for identifying and permitting eligible banks to adopt irb / advanced measurement approaches. 3 / 7 as per normal practice, and with a view to ensuring a smooth migration to basel ii, a consultative and participative approach has been adopted for both designing and implementing basel ii. a steering committee comprising senior officials from 14 banks ( public, private and foreign ) has been constituted with representation from the indian banks ’ association and the rbi. the steering committee had formed sub - groups to address specific issues. on the basis of recommendations of the steering committee, draft guidelines to the banks on implementation of the new capital adequacy framework have been issued. implementation of basel ii will require more capital for banks in india due to the fact that operational risk is not captured under basel i, and the capital charge for market risk was not prescribed until recently. though the cushion available in the system, which at present has a crar of over 12 per cent, is comforting, banks are exploring various avenues for meeting the capital requirements under basel ii. even while we have decided to take the indian banking system on to the simple approaches under basel ii, we have taken some initiatives which would clearly demonstrate that we have no intentions of either diluting the standards or picking on the less stringent options laid down in basel ii. through these initiatives, we have prescribed stringent prudential requirements for banks in india e. g. with regard to adoption of risk weights for claims on state governments, public sector enterprises, banks and for capital market and real estate exposures. further even though banks can be allowed to use unsolicited ratings under the standardised approach, we would not allow the use of unsolicited ratings. also, we have been expanding the area of disclosures so as to have greater transparency with regard to the financial position and risk profile of banks. illustratively, with a view to enhancing further transparency, all cases of penalty imposed by the rbi on the banks as also directions issued

been commensurate with inflation control. the above three considerations will suggest that the recent persistence of inflation is a puzzle. i will come back to the causes of the recent bout of inflation ; but before that, let me address the question as to why do we need to worry about high inflation? costs of inflation inflation, though a nominal variable, imposes real costs on the economy. let me elaborate. first, inflation erodes the value of money. as i mentioned earlier, india is a moderate inflation country with the 62 - year long - term average inflation rate being 6. 7 per cent, notwithstanding occasional spikes in inflation. yet during this period the overall price level has multiplied 45 times. this means that 100 now is worth only 2. 2 at 1950 – 51 prices. since price stability is a key objective of monetary policy, central banks are obviously concerned with inflation. second, high and persistent inflation imposes significant socio - economic costs. given that the burden of inflation is disproportionately large on the poor, and considering that india has a large informal sector, high inflation by itself can lead to distributional inequality. therefore, for a welfare - oriented public policy, low inflation becomes a critical element for ensuring a balanced progress. third, high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. fixed - income earners and pensioners see a decline in their disposable income and standard of living. inflation reduces households ’ savings as they try to maintain the real value of their consumption. consequent fall in overall investment in the economy reduces its potential growth. with a high inflation of over two years we are already seeing a fall in household savings in financial assets, particularly in bank deposits. at the same time households ’ preference for gold has increased. this is putting additional pressure on our balance of payments. fourth, economic agents base their consumption and investment decisions on their current and expected future income as well as their expectations on future inflation rates. persistent high inflation alters inflationary expectations and apprehension arising from price uncertainty does lead to cut in spending by individuals and slowdown in investment by corporates which hurts economic growth in the long - run. fifth, as inflation rises and turns volatile, it raises the inflation risk premia in financial transactions. hence, nominal interest rates tend to be higher than they would have been under low and stable inflation. sixth, if domestic inflation remains persistently higher than those of the trading partners, it