however, there is another area relating to the banking sector that we cannot overlook when we compare indian banking practices with the rest of world and that relates to ‘ financial inclusion ’. stepping beyond the banking sector and looking at other core areas of functioning of the central bank, such as foreign exchange reserves management and payments systems also suggest several homegrown practices which are now being regarded as the international best practises. 6. let me begin with prudential regulations. statutory liquidity ratio1 and liquidity coverage ratio2 7. in the wake of the global financial crisis 2007 – 08, the basel committee on banking supervision ( bcbs ) initiated the liquidity coverage ratio ( lcr ) in an effort to strengthen the liquidity framework of the financial systems of the world. bank portfolios generally consist of illiquid assets ( longer - term loans ) that are funded by liabilities ( shorter - term borrowings ) that must be renewed continuously until the longer - term customer loans are fully repaid. episodes of uncertainty, however, can cause increases in short - term rates relative to long - term rates, which can translate into a run on and insolvency for financial institutions. to prevent such run on a daily 1 / 7 bis central bankers'speeches basis, banks need to hold unencumbered, marketable assets that would find buyers at a short notice. a reserve requirement alone may not help enough as a prudential measure for managing liquidity risk ; banks world - wide, for lack of incentives to hold up funds in unremunerated reserves, have often resorted to circumventing the statute by veering away from one form of funding to other in an effort to modify the base for calculating the ratio. the extensive use of short term wholesale funding to fund long term assets in the recent crisis being a case in point. 8. before the global crisis, usa in particular did not have any concept of liquidity asset ratio requirement from either prudential or monetary control point of view. more recently, liquidity risk management has been manifested in various stress - testing methods as per supervisory guidance. other developed countries that never had or abolished liquidity asset ratios or traditional reserve requirements so far were canada, france, sweden, and new zealand. 9. indian banks, however, have always had in place a liquidity risk management system in the form of the statutory liquidity ratio ( slr ). according to section 24 ( 2 - a ) of the banking

in order to achieve a set of objectives such as support and maintain confidence in the monetary and exchange rate policies, limit external vulnerabilities by maintaining foreign currency liquidity to absorb shocks during times of crisis, to provide a level of confidence to markets, demonstrate the backing of domestic currency by external assets and meeting its foreign exchange needs and external debt obligations. 27. however, the design of investment portfolios varies widely across countries, reflecting essentially the exposure to liquidity, currency, interest rate and counterparty credit risks and the scope of active management thereof. portfolio design takes into account a host of factors such as exchange rate regime adopted by the country, the extent of openness of the economy, the size of the external sector in a country ’ s gdp and integration of financial markets. 5 / 7 bis central bankers'speeches 28. india has been frontrunner in terms of international best practices in the management of foreign exchange reserves. according to latest international monetary fund ( imf ) guidelines, reserve management should seek to ensure that ( 1 ) adequate foreign exchange reserves are available for meeting a defined range of objectives ; ( 2 ) liquidity, market, credit, legal, settlement, custodial, and operational risks are controlled in a prudent manner ; and ( 3 ) subject to liquidity and other risk constraints, reasonable risk - adjusted returns are generated over the medium to long term on the funds invested. the broad objectives of reserve management in india runs on similar lines. while liquidity and safety constitute the twin objectives of reserve management in india, return optimisation is kept in view within this framework. it can be found even in the preamble of the reserve bank of india ( rbi ) act 1934, ‘ to use the currency system to the country ’ s advantage and with a view to securing monetary stability ’. here monetary stability may be interpreted as internal as well as external stability, implying stable exchange rate as one of the overall objectives of the reserve management policy. while internal stability implies that reserve management cannot be isolated from domestic macroeconomic stability and economic growth, the phrase ‘ to use the currency system to the country ’ s advantage ’ implies that maximum gains for the country as a whole or the economy in general, could be derived in the process of reserve management7. 29. the reserve bank of india act, 1934 provides the overarching legal framework for deployment of reserves in different foreign currency assets ( fca ) and gold within the broad parameters of currencies, instruments