to the real sector is huge especially on the vulnerable segments of society. urban co - operative banks – the weak link the tightening of regulation over the banking and nbfc sectors saw the gravitation of risk to the lightly regulated urban co - operative banks ( ucbs ) which were under dual regulation of the rbi and the registrar of cooperative societies. the stock market crash in 2002 triggered a payments problem and it was found that the nexus between the broker and a large ucb ( madhavpura mercantile co - operative bank ) led to huge exposure to the broker and the bank collapsed. the systemic implication was that hundreds of small ucbs had exposure to this bank and the collapse of these banks would have been very disruptive though confined to a small region. the deposit insurance and credit guarantee corporation ( dicgc ) had to make a large payout to the collapsed bank under a restructuring package and averted the domino effect. but the madhavpura bank collapse led to erosion in public confidence and there were a series of ucb failures across the country. the immediate measures taken were to ban connected lending, exposure to share - brokers and inter - ucb deposits. the supervisory system – both on - site and off - site – was triggered and strengthened. in 2004, all new branch and bank expansion was stopped and a vision document was put out in 2005 which provided for a mou with the state governments to work out a way for non - disruptive exit of weak ucbs while simultaneously incentivising the growth of strong banks. subsequently various resolution options have been provided such as merger with or without support from dicgc, restructuring of liabilities, introduction of new capital - like instruments, and transfer of assets and liabilities. the ucb sector has seen a reduction in the number of weak banks from 725 to 496. 102 banks have gone out of the system through mergers and liquidation. dicgc has also strengthened its claim payments system to ensure that prompt relief is given to small depositors of failed banks. the lessons learnt were : • in dealing with a crisis arising out of interconnectedness, breathing time needs to be provided through liquidity injection. • reduce interconnectedness within the financial system as it leads to a “ moral hazard ” problem of “ too interconnected to fail ”. • the most lightly regulated entity in the financial system becomes the weakest link. the system's weakest link becomes a source of reputation risk and erosion in public

able to do so with ease at minimum cost. principle - based regulations for interest rate derivatives and foreign exchange derivatives aim at achieving this 2 / 5 bis central bankers'speeches broad objective. detailed procedural prescriptions have been replaced with basic principles, thereby allowing – greater operational flexibility for market participants. earlier restrictions on design of derivative contracts and cancellation and rebooking of foreign exchange derivatives have been dispensed with. distinctions based on residency have been removed or reduced, bringing foreign participants at par with domestic entities in terms of market entry and exit. while retaining the existence of underlying exposures as the basis for access, greater flexibility and ease of hedging have been brought in by allowing anticipated exposures to be hedged. users with limited / small hedging requirements have been allowed to enter into contracts equivalent of usd 10 million without the need to establish the existence of underlying exposures. 13. simplifying regulations and providing procedural flexibilities have also contributed to easing operating conditions and thereby reducing costs and inefficiencies. while some operational constraints are inevitable, especially those warranted by prudential considerations, our approach has been to ease operating conditions within these considerations. another example of this is the recent passing of the bilateral netting of qualified financial contracts act, 2020, which addresses an important operating constraint. the absence of legal recognition for bilateral netting had discouraged the use of derivatives for effective risk management. the legislation provides the enabling framework for cash and derivative market transactions to be off - set. this will enable optimization of capital requirement for financial institutions and will provide an impetus for the development of derivative markets. internationalisation of financial markets 14. internationalisation of financial markets can lower transaction costs with efficiency gains. over the last three decades, india has undergone a transformation from being a virtually closed economy to one that is globally connected and open to a much larger volume of international transactions and capital flows than before. today, the capital account is convertible to a great extent. inward foreign direct investment ( fdi ) is allowed in most sectors and outbound fdi by indian incorporated entities is allowed as a multiple of their net worth. the external commercial borrowing framework has also been significantly liberalised to include more eligible borrowers, even as maturity requirements have been reduced and end - use restrictions have been relaxed. 15. foreign portfolio investment in indian debt markets has been expanded within calibrated macro - prudential norms. limits under the medium - term framework for investment by foreign portfolio investors ( fpis