independent expert, lamfalussy was one of the foremost proponents of the view that policy interactions in a monetary union had to be governed by a proper framework, and not just left up to ad hoc coordination and market discipline. 1 my main argument today is that lamfalussy was right – and in more ways than even recognised. a monetary union creates complex interactions which have to be governed by a strong and comprehensive framework. many of these interactions we have only really james, h. ( 2012 ), making the european monetary union, p. 248. see also maes, i. ( 2011 ), “ the evolution of alexandre lamfalussy ’ s thought on the international and european monetary system ”, national bank of belgium, working paper research, no. 217. bis central bankers ’ speeches understood thanks to the crisis. and in crucial areas, such as structural policies, we have still not adequately responded. independence and interdependence between policies in any polity there is always a tension between economic policies. on the one hand, decision - makers in different policy areas act independently. but on the other, they inevitably have to take into account what the others are doing – they are interdependent. this is an inherent struggle which, if left to itself, can produce outcomes that no party really wants. for example, central bank independence is a necessary condition for monetary policy to focus on its core price stability mandate. it is an essential feature of europe ’ s constitutional order and puts the onus on governments not to intervene in the policy - making, management and budget of central banks, including in those countries which have not yet adopted the euro, such as here, in hungary. but independence is not a sufficient condition to ensure that monetary policy calls the shots, as we know from literature on monetary and fiscal dominance. 2 essentially what this literature finds is that if fiscal policy is not constrained by a rule which ensures the sustainability of debt, the central bank is ultimately forced into inflationary policies. at the same time, inflation can make output stabilisation through fiscal policy less effective, as workers ’ expectations adapt and prices rise faster than incomes. so all parties lose out. the conclusion is that managing interdependence requires a strong framework. policymakers must decide which aims they want to prioritise and construct a set of rules which promotes that and sets incentives right. in the euro area, we consciously built our framework around “ monetary dominance ” – ensuring that the

r gandhi : indian banking at crossroads – challenge of risk management from globalisation to financial inclusion valedictory address by mr r gandhi, deputy governor of the reserve bank of india, on the occasion of seminar on banking, organized by the indian merchant ’ s chamber, mumbai, 8 may 2014. * * * assistance provided by ms. anupam sonal in preparing this speech is gratefully acknowledged. 1. shri shailesh vaidya, chairman, indian merchants ’ chamber ( imc ), shri chandan bhattacharya, chairman, finance and banking committee, imc and delegates to this imc national seminar, a very warm good evening! it is an honour for me to be here today to deliver the valedictory address of this national seminar organised by imc. the seminar provides an opportunity to consider the developments in the banking risk management, assess the recent experience in this space and work on the way ahead. why risk management assumes greater significance in banks 2. most business activities and operations are driven by considerations of returns or profitability. however the search for returns exposes the businesses to risks. also risks escalate and multiply with returns sought – banks are no different ; only the element of riskiness in the banks ’ business and operations is higher as they not only carry out their operations with borrowed money and with high leverage but also attempt to provide a vast range of financial services. 3. banks perform multifarious functions. however financial intermediation and maturity transformation are by far the most significant activities performed by banks. banks essentially have a liquid liability profile, as against an illiquid asset profile, which makes them vulnerable to runs and in this process alone, they generate or are exposed to different types of risks. credit, market and operational risks are the three primary risks that have a substantial bearing on the performance of banks. there are a number of other types of risks, emanating both from within and without that the banks are exposed to in their day to day functioning. 4. further, banks are intricately linked to the various segments in the financial sector and the economy. problems emanating from the banking sector can cause wide spread destabilization to the segments to which it is, directly or indirectly linked. 5. as the banks perform this role of intermediation in fiduciary capacity, ensuring a balance between the risks and returns assumes significance and the effort towards achieving this balance can be referred to as risk management