the counterparty. change in legal environment due to legislative changes and court interpretations / proceedings also result in legal risk. legal risk includes risk of nonenforceability of contract or in - correct documentation resulting in the increased probability of loss. broadly, legal risks may result in ( i ) claims against institution, ( ii ) fines, penalties, punitive damages, ( iii ) unenforceable contracts resulting from defective documentation, and ( iv ) loss of institutional reputation. documentation forms an important part of the banking and financial sector. for many, documentation is a panacea to the legal risks that may arise in banking activities. but then it has also been realized and widely acknowledged that loopholes exist in these documentations. as a result of lessons learnt from time to time, the loopholes in the documentation are attempted to be plugged by adding further terms and conditions in existing documents or by adding further documents resulting in voluminous and confusing documentation. in banking there is no end to innovation in documentation because, for keeping pace with the changing needs and aspirations of the customers, banks have been venturing into various kinds of innovative products. identifying the legal risks that lurk behind modern techno - savvy complex transactions and market jargon, is no easy task. the starting point while entering into any financial transaction is the legal capacity to contract and this becomes complex to interpret in respect of innovative financial instruments, since laws or regulators may not have kept pace with financial innovation. the risk of loss due to non - enforceability of the contract in a court of law as one of the counterparties lacks the legal capacity to contract was witnessed in the case of hammersmith & fulham, uk. in this case, the city councils had entered into a series of interest rate swaps with banks, which turned out to produce major losses for the councils due to increase in british interest rates. the swaps were later ruled invalid by british courts as the city councils did not have the authority to enter into such transactions and were found to be ultra vires. as a result, the loss had to be absorbed by the counterparty banks. lessons of the crisis some of the key legal risks faced by entities in the recent financial crisis related to bankruptcy risks, mis - selling of complex derivatives, enforceability of contracts / agreements backing otc transactions across jurisdictions and the hitherto untested risks in the securities market – custodial arrangements, repo transactions, tripartite agreements, securities lending etc. over the

shyamala gopinath : changing dynamics of legal risks in the financial sector inaugural address by ms shyamala gopinath, deputy governor of the reserve bank of india, at the symposium on “ changing dynamics of legal risks in the financial sector ”, kochi, 30 october 2009. * * * it gives me great pleasure to be amidst you all today to inaugurate this symposium. at the outset, i may say that this symposium on “ changing dynamics of legal risks in the financial sector ” could not have been organized at a more appropriate time than now. the recent global financial crisis has brought to light various risks. it has to a great extent blurred the distinction between operational risks and legal risks. as they say, each crisis opens up opportunities for learning and innovation ; it is just the right time for the legal fraternity to put on their thinking cap and investigate which of the many risks that culminated in the crisis may be identified as legal risks and what legal steps could have been taken that would have mitigated its effects. contextually in the wake of increased financial integration and globalization, it is essential that in - house legal officers also have an understanding of legal risks from a cross border point of view. i have no doubt that a symposium like this in which heads of legal departments of various regulators, banks and financial institutions are participating where they will have an opportunity to interact with distinguished speakers having rich experience in the field, drawn from within the country and abroad, will provide a proper direction to identify and deal with legal risks. as a central banker with three decades of experience i have had occasions to deal with diverse operational problems and difficult issues. i have no hesitation in saying that inputs received from the legal department of rbi have been very useful. at times one may feel that the legal opinion is a bit too rigid and conservative and fails to recognize the dynamics of the sector, but in the end we all need to appreciate that legal risks have to be accorded prime consideration and addressed. what is legal risk? there appears to be no concrete definition for the expression “ legal risk ” nor do i venture to make an attempt at defining it considering the complexities and variations in the risks involved. the basel ii accord covers “ legal ” risk under “ operational ” risk. legal risk may vary from institution to institution depending on the manner in which it conducts its business and the documentation it follows. the legal risks primarily arise either due to lack of clarity of the documentation of the product or the act of