guardians of financial stability, they do need to perform functions that are more complex. should central banks be lenders of last resort to the system as a whole by injecting systemic liquidity through open market operations only, or should they also provide liquidity to individual financial institutions that are judged to be solvent but illiquid? how do they arrive at such judgments if they do not have adequate information on individual institutions? can they have such detailed information without ongoing responsibilities for regulation and supervision? this issue is not dissimilar, in terms of the existence of asymmetric information to that of the problem of adequate transparency of information related to the value of collateral underlying asset backed securities. banks and financial institutions are typically highly leveraged institutions : thus judgements related to their solvency depend on the valuation of their assets at the time when difficulties arise. in the current case, banks have invested through a chain of vehicles in securities whose values are in doubt. when providing lolr liquidity support, how is the central bank to make a judgement on the solvency of institutions to whom it is providing liquidity? as a greater recognition and appreciation of the appropriate role of central banks gains ground, it is possible that this will result in further rethinking on the functioning of central banks. a case in point is the separation of financial regulation and supervision from monetary policy which could have resulted in ineffective and inadequate surveillance in the context of the current crisis. there is a view that problems of information asymmetry might have got further aggravated with banks reporting both to the monetary authority and the regulatory body in charge of banking supervision. in reviewing the evolution of central banks, one is struck by the constant evolutionary change that they have undergone over time, and the differences in their functions across different countries. their functions have changed almost continuously in response to evolving circumstances. in fact, it is the occurrence of financial instability that led to the formation of some central banks, most notably, the founding of the us federal reserve after the 1907 financial crisis in the united states. thus, it will be interesting to see how thinking evolves as a result of the current crisis. reams are already being written in the thoughtful financial press and much more is to come. we had begun to forget the danger of contagion and the speed with which it takes place when it does occur. the current developments which began in a relatively minor segment of the financial market, viz., the sub - prime mortgage segment, have spread far

he could not pay he was beheaded. punishments became less harsh over time. if you defaulted in victorian england, you went to debtor ’ s prison. today, the borrower typically only forfeits the assets that have been financed, and sometimes personal property too if he is not protected by limited liability, unless he has acted fraudulently. why should the lender not share in the losses to the full extent? that is because he is not a full managing partner in the enterprise. in return for not sharing in the large profits if the enterprise does well, the lender is absolved from sharing the losses when it does badly, to the extent possible. by agreeing to protect the lender from “ downside ” risk, the borrower gets cheaper financing, which allows him to retain more of the “ upside ” generated if his enterprise is successful. moreover, he can get money from total strangers, who have no intimate knowledge of his enterprise or his management capabilities, fully reassured by the fact that they can seize the hard collateral that is available if the borrower defaults. this is why banks offer to finance your car or home loan today at just over 10 percent, just a couple of percentage points over the policy rate. violating the spirit of debt the problem i want to focus on in this lecture is that the sanctity of the debt contract has been continuously eroded in india in recent years, not by small borrower but by the large bis central bankers ’ speeches borrower. and this has to change if we are to get banks to finance the enormous infrastructure needs and industrial growth that this country aims to attain. the reality is that too many large borrowers see the lender, typically a bank, as holding not a senior debt claim that overrides all other claims when the borrower gets into trouble, but a claim junior to his equity claim. in much of the globe, when a large borrower defaults, he is contrite and desperate to show that the lender should continue to trust him with management of the enterprise. in india, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. the firm and its many workers, as well as past bank loans, are the hostages in this game of chicken – the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive. and if the enterprise regains health,