##es and ultimate liquidity providers, whatever be the form of the financial market model. the gradual process to introducing structural reforms in the banking sector was a unique experiment undertaken with the key objective of strengthening the banking sector balance sheets and governance frameworks in a non - disruptive manner while managing the given political - economy considerations. the reforms were carefully sequenced in terms of instruments and objectives. thus, prudential norms and supervisory strengthening were introduced early in the reform cycle, followed by interest rate deregulation and gradually lowering of statutory preemptions. the more complex aspects of legal and accounting measures were ushered in subsequently when the basic tenets of the reforms were already in place. more recently, the regulatory framework has also focused on ensuring good governance through " fit and proper " owners, directors and senior managers of the banks. broadly speaking, the evolution of regulatory framework for financial sector entities has been intrinsically derived from the objective of financial stability which has always been an objective for the rbi. a unique feature of the reform of public sector banks, which dominated the indian banking sector, was the process of financial restructuring. banks were recapitalized by the government to meet prudential norms through recapitalization bonds ( no cash payment was made ). the mechanism of hiving off bad loans to a separate government asset management company was not considered appropriate in view of the moral hazard. the overhang of nonperforming loans had to be managed by the banks themselves. the subsequent divestment of equity and offer to private shareholders was undertaken through a public offer and not by sale to strategic investors. consequently, all the public sector banks, which issued shares to private shareholders, have been listed on the exchanges and are subject to the same disclosure and market discipline standards as other listed entities. the cost of recapitalization to gdp has been low relative to experience in other countries. on a cumulative basis it worked out to about one percent of the gdp and the value of the equity rajan, zingales, university of chicago. held by government is much above the amount recapitalized. all these recapitalization bonds have since been converted to marketable securities. the financial system has since expanded significantly across various segments and a number of cross - sector organisational forms combining banks, insurance companies and investment firms have emerged. in respect of certain identified conglomerates based on well defined criteria, there is an inter - regulatory mechanism for focused monitoring and supervision. however, in most

##dels that had been the focus of so much work in the 1960s came under attack on two fronts. most prominently, greater recognition of the importance of expectations suggested that those models, which for the most part incorporated autoregressive expectations, were excessively reduced - form and backward - looking in nature and thus insensitive to changes in economic structure and the policy process. in addition, some researchers observed that simple time - series models often produced better forecasts than the large macromodels of that period. 4 one prescription was to focus on uncovering, at a more fundamental level, the structural parameters of the economy. needless to say, this task has proven to be a very tall order that has yet to be filled. partly in response to these difficulties, a substantial body of research focused on improvements in empirical modelling, such as vector autoregressions for forecasting, and in some cases, for policy analysis. see romer, christina d. and david h. romer, " the evolution of economic understanding and postwar stabilization policy, " nber working paper no. 9274 ( october 2002 ), p. 39. friedman, milton. " the role of monetary policy ", american economic review, vol. 58, no. 1 ( march 1968 ) pp. 1 - 17. phelps, edmund s. " the new microeconomics in inflation and unemployment theory ", american economic review ( may 1969 ) pp. 147 - 160. friedman, milton and anna jacobsen schwartz. a monetary history of the united states, 1867 - 1960. princeton university press, princeton, nj, 1963. sims, christopher a. " macroeconomics and reality ". econometrics, vol. 48, no. 1 ( january 1980 ). pp. 1 - 48. each one of these approaches has proven useful, and their descendants are currently employed in various forms in central banks throughout the world. but as yet, none of these approaches is capable of addressing the full range of policymakers'needs. at various points in time, some analysts have held out hope that a single indicator variable - such as commodity prices, the yield curve, nominal income, and of course, the monetary aggregates - could be used to reliably guide the conduct of monetary policy. if it were the case that an indicator variable or a relatively simple equation could extract the essence of key economic relationships from an exceedingly complex and dynamic real world, then broader issues of economic