gurumoorthy mahalingam : some thoughts on forex markets in india keynote address by mr gurumoorthy mahalingam, executive director of the reserve bank of india, at the india treasury summit, mumbai, 25 february 2015. * * * contribution by shri anand prakash, director, financial markets operations department in preparing the speech is gratefully acknowledged. introduction it is indeed a pleasure for me to be here at the india treasury summit to share my thoughts on the indian foreign exchange market. this forum provides an important platform for interaction amongst the corporate treasurers, finance professionals and market participants and it is being held at a time when the financial world is beset with uncertainties regarding economic growth prospects, oil and commodity prices and monetary policy stances of major economies. given this uncertainty as the backdrop, i would like to touch on some key issues which impact the development of indian forex markets. indian forex market has come a long way foreign exchange market in india has developed significantly in the post - reforms era following the phased transition from a pegged exchange rate regime to a market determined exchange rate regime in 1993 and the subsequent adoption of current account convertibility in 1994. with the abolition of liberalized exchange rate management system ( lerms ) in 1993, the exchange rate of the rupee became market determined. there has been a significant increase in both depth and liquidity in the spot as well as forward market segments, which could be gauged from the rise in the average daily forex market turnover from approximately us $ 16 billion in 2005 – 06 to nearly us $ 55 billion in 2014 – 15 so far. the depth of the foreign exchange market can also be gauged from the fact that the bid - offer spread in usd - inr pair is quite narrow now. in the context of integration of indian financial market with international markets, the approach of reserve bank of india to market development has been that of cautious gradualism, informed by the experience of other developed and developing countries. even within the constraints imposed by a gradualist approach, reserve bank and the government of india have taken several steps that include progressive liberalization of capital flows, calibrated increase in investment limits for foreign institutional investors ( fiis ) in government and corporate debt, introduction of qualified foreign investor ( qfis ) as a separate investor class, expansion of the menu of risk management instruments, etc. proper risk management system is another issue of utmost importance where significant progress has been made. the setting up of clearing corporation

). also in the same month, the bsp issued the guidelines for the capital treatment of banks ’ investment in credit - linked notes ( clns ) and similar credit derivative products ( circular no. 417 ). in april 2004, the bsp issued guidelines for the treatment of compliance risk and to further strengthen banks ’ compliance function ( circular no. 429 ). and more recently, in june 2004, the bsp issued the guidelines for the development and implementation of banks ’ internal risk rating systems ( circular no. 439 ). journey to basel ii the simplified approach of basel i has been successful in boosting capital levels in the global banking system from what were considered uncomfortably low levels throughout the late 1970s and early 1980s. its major shortcoming, however, is that the “ risk weights ” poorly represent the likelihood of sustaining losses and such lack of risk sensitivity can lead to misallocation of scarce financial resources and hamper long - term economic growth. the new capital accord otherwise known as basel ii, formally unveiled last june 26, is seen to make capital requirements to be more risk sensitive than basel i. it allows greater reliance on the banks ’ internal systems for setting the capital requirements. more importantly, it provides incentives for banks to continuously improve their risk management practices. however, basel ii poses challenges to philippine banks and the bsp. banks will have to develop a more disciplined, rigorous, and auditable approach to risk assessment. this challenge has many dimensions and technology will only address some of them. for the bsp, our challenge is to build up technical knowledge and supervisory resources to validate bank ’ s risk management systems. we will also need to examine our existing charter to see to it that we have the necessary powers to implement basel ii, particularly pillar 2. the risk management standards and practices embodied in basel ii are real and are drawn from the best practices of large internationally active banks. it reflects the many insights gathered through practical experience, including both successes and failures in risk management. it contains many useful lessons and can serve as a good roadmap on how to improve internal risk management. however, we acknowledge that not all aspects of basel ii will be of use to every bank. for example, some of the quantification tools used in large complex institutions may not be necessary for the smaller and less sophisticated institutions. and some risks inherent in the activities of banks which are internationally active may be remote to those which are merely active domestically. this is the reason for modifying the philippine