v leeladhar : indian banks and the global challenges inaugural address by mr v leeladhar, deputy governor of the reserve bank of india, at the seminar on “ indian banks and the global challenges ”, organized jointly by the indian merchants ’ chamber and the indian banks ’ association, mumbai, 31 january 2006. * * * it gives me great pleasure and privilege to participate in the seminar jointly hosted by indian merchants'chamber and iba at a juncture when financial services sector across jurisdictions is going through a strong phase of increasing globalisation. integration of economies leads to integration of financial markets catalyzing the globalisation process. the growing role of the financial sector in allocation of resources has significant potential advantages for the efficiency with which our economy functions. consequently, the adverse consequences of malfunction of the financial system are likely to be more severe than they used to be in the past. hence, all our efforts today are focused at ensuring greater financial stability. given the significance of the indian banking system, one cannot afford to underplay the importance of a robust and resilient banking system. 2. the enhanced role of the banking sector in the indian economy, the increasing levels of deregulation along with the increasing levels of competition have facilitated globalisation of the india banking system and placed numerous demands on banks. operating in this demanding environment has exposed banks to various challenges. the last decade has witnessed major changes in the financial sector - new banks, new financial institutions, new instruments, new windows, and new opportunities - and, along with all this, new challenges. while deregulation has opened up new vistas for banks to augment revenues, it has entailed greater competition and consequently greater risks. demand for new products, particularly derivatives, has required banks to diversify their product mix and also effect rapid changes in their processes and operations in order to remain competitive in the globalised environment. globalisation – a challenge as well as an opportunity 3. the benefits of globalisation have been well documented and are being increasingly recognised. globalisation of domestic banks has also been facilitated by tremendous advancement in information and communications technology. globalisation has thrown up lot of opportunities but accompanied by concomitant risks. there is a growing realisation that the ability of countries to conduct business across national borders and the ability to cope with the possible downside risks would depend, interalia, on the soundness of the financial system and the strength of the individual participants. adoption of appropriate prudential,

of market infrastructure 5. appropriately, in this context, is an observation made in an imf staff position note 6 in respect of the financial system prior to the crisis : “ financial systems and transactions became distorted along several dimensions, that is, financial system grew highly complex, opaque, over - leveraged and heavily interconnected ; liquidity risk was higher than recognized ; large complex institutions enjoyed the benefits of being “ too important to fail ” and financial intermediation has increasingly shifted to the shadow banking sector. ” the two dimensions of systemic risks cutting across specificities, the different perspectives of systemic risks can be grouped into two dimensions – a time dimension and a cross sectional dimension. the time dimension of systemic risks, or what is more commonly known as procyclicality, relates to the progressive build - up of aggregate risk over time. the second dimension of systemic risk – common exposures / interlinkages in the cross section focuses on how risk is distributed within the financial system at any given point in time. an analytical framework to identify systemic risks must operate in both dimensions. assessing systemic risks as i mentioned earlier, the international financial crisis has refocused policy attention on systemic risks and forced us all to think much harder – about what systemic risk means, how it can be measured and what implications does it have for policy. there is a general consensus that systemic risk was underestimated across the board before this crisis and also that there is a pressing need to assess and evaluate such risks on an ongoing basis. considerable efforts are ongoing, both internationally and amongst systemic regulators domestically, to develop a framework for assessing systemic risks and for potentially predicting systemic events. the objective is to put in place an assessment infrastructure which is capable of raising “ flags ” i. e., signalling trends that could make markets or countries vulnerable to unanticipated events. with the increasing realization that systemic risks per se are generally complex, very often opaque, and always multifaceted, came the realization that the identification of such risks is “ risk measurement and systemic risk ”, andre icard, deputy general manager of the bank for international settlements, at the fourth joint central bank research conference on risk measurement and systemic risk, european central bank, frankfurt, 8 november 2005. “ shaping the new financial system ”, the international monetary fund ( imf ) staff position note ( spn ) spn / 10 / 15. bis central bankers ’ speeches also far from straightforward. it was felt that in order to see “