kishori j udeshi : in quest of new cheese speech by ms kishori j udeshi, deputy governor of the reserve bank of india, at the indian banks ’ association seminar, mumbai, 26 april 2005. * * * iba deserves to be complimented for having organised this seminar on the subject of “ in search of new cheese – towards newer profit avenues ”. the subject holds considerable contemporary relevance coming as it does at a time of intense competition, thinning margins, rising yields, and dwindling trading profits. as we look back we can see that the declining interest rate scenario during the last three to four years coupled with prudent regulation, in alignment with international standards and effective supervision has strengthened the balance sheets of banks. it ’ s a different matter that had the asset quality been as it should have been, the profits could have been more gainfully utilised. what is of concern however, is whether the reduced npa levels reported are sustainable through stronger credit appraisal processes built up over the years or are they only a result of massive provisioning which will be difficult to sustain in a scenario of rising bond yields. only time will tell. before i talk of cheese let me begin by chalking out two issues on the expenditure side in the future scenario. this chalk may serve to highlight the quest for cheese. first and foremost, banks would need to invest heavily in technically qualified professionally skilled staff. for this you recognise to invest in arms i. e. attract, retain and motivate staff. turnover of such staff in banks is going to be as volatile as it is for the bpo firms and compensation structures would need heavy revamping. this should necessarily be accompanied by good hrm system which can measure performances. secondly, although technology deployment in banks has increased remarkably, this has not been leveraged to the maximum extent essential to achieve and maintain high service and efficiency standards. in effect, managing technology, is still a key challenge for indian banks. we have, therefore, had to settle for just the standardised approach under basle ii. we need to move to advanced approaches under basle ii in order to achieve greater efficiency of capital and be competitive in india as also globally. for this, banks not all but certainly the large and significant banks need to invest heavily in advanced technology which is another item of expenditure that cannot be avoided in the near future. given this backdrop, can banks make profits by the same old 3 - 6 -

place outside the regulated banking system. focusing on the pre - requisites for sustenance of shadow banking, claessens and ratnovski ( 2014 ) have described shadow banking as all financial activities, barring traditional banking, which require a private or public backstop ( in the form of franchise value of a bank or insurance company, or in the form of a government guarantee ) to operate. 4. in the last two to three decades, growing innovations in the financial sector, changes in regulatory framework and growing competition with non - bank entities caused banks to shift a part of their activities outside the regulatory framework. this contributed to the growth of shadow banks. as a result, shadow banking activities have evolved over time in response to newer set of regulation and supervisory guidelines and spread in the domains where the scope for regulatory arbitrage was higher. it emerged not only as an avenue for exploiting see financial stability board ( 2012 ). bis central bankers ’ speeches regulatory arbitrage but also in response to market demand for innovative financial instruments that could mitigate risks and yield higher returns. 5. the recent global financial crisis brought to fore the need for monitoring and regulating the activities of shadow banking. there is, nevertheless, a concern that the forthcoming implementation of basel iii, which has more stringent capital and liquidity requirements for the banks, might further push the banks to shift part of their activities outside of the regulated environment and therefore increase shadow banking activities. size of shadow banks 6. one cannot precisely gauge the size of shadow banking as the activities lack transparency. according to the fsb report ( 2013 ), size of global shadow system expanded to us $ 71 trillion2 in 2012. in 2012, the assets of other financial intermediaries, which undertake non - bank financial intermediation, accounted for about 24 per cent of total financial assets, about half of banking system assets and 117 per cent of gdp of the above - said 25 jurisdictions. the largest system of non - bank financial intermediation in 2012 was found in the usa, which had assets size of us $ 26 trillion, followed by the euro area ( us $ 22 trillion ), the uk ( us $ 9 trillion ) and japan ( us $ 4 trillion ). the size of shadow banking in a large number of emerging market economies ( emes ) was found to have increased in 2012, nevertheless, the share of non - bank financial intermediation remained relatively smaller at less than 20 per cent of gdp. as