countries still need to be further developed in terms of size, depth and functioning. this applies, in particular, to the banking sector that largely dominates the financial sector of these economies. the challenges ahead are numerous : inter alia, the weakness of banking intermediation, reflected in the low level of credit to the private sector, the relatively large proportion of bad loans in banks'balance sheets in some countries or the exceptionally high spreads between lending and deposit rates that will progressively vanish in the next years. fortunately, the privatisation process and the increasing participation of foreign investors in the banking system have supported the rehabilitation and transformation of formerly state banks into efficient and profitable banking institutions. efforts to strengthen the financial and banking systems need to be made in the next years, also for the fulfilment of the so - called " economic " copenhagen criterion, which requires the existence of functioning market economies and the ability to cope with competitive pressures. compliance with this criterion for eu accession will require the adoption of eu legislation in the area of financial services, including those related to banking, insurance and investment firms, as i have mentioned before. all in all, in order to fully comply with the acquis communautaire, it would be necessary to further advance institutional reforms related to the applicability and enforcement of laws, in particular as regards the enhancement of corporate governance and legal frameworks. finally the development of a stable and well - functioning financial sector in the accession countries is also key to the smooth conduct of monetary policy in an enlarged euro area. efficient and competitive banking sectors as well as smooth functioning capital markets are needed to ensure macroeconomic and financial stability in the accession countries and to support the convergence process of these economies. they are also needed for the proper conduct of monetary policy and, thus, for the successful participation of accession countries in the euro area. indeed, deep and liquid capital markets are key to enabling an efficient use to be made of monetary policy instruments, since structural weaknesses in the banking sector could have severe implications for the monetary policy transmission mechanism and could affect the responsiveness of banks to changes in the monetary policy stance. the impact of enlargement on the monetary policy of the ecb enlargement will imply important new challenges for the monetary policy of the ecb. nevertheless, there is no doubt that the ecb will be able to ensure the continuation of price stability, even in an enlarged euro area, in a credible and lasting manner. at the technical level – as

which is taken as a basis for intermediate targeting ; and in such circumstances, one needs to look also at other relevant indicators. it is not that such dilemmas are specific to us and by and large, countries follow a menu approach or a ‘ check list ’ to track a number of relevant variables. fourthly, the dilemma that the central bank faces as a manager of public debt and the monetary authority is well known. while the former may require keeping its cost low, the latter may demand a reduction in the extent of government debt that it holds, considering the impact it has on aggregate expenditures and thus on demand. the market - borrowing programme of the government is determined by the fiscal parameters, but the size of the government debt impacts on the interest rates in the economy and it should be clearly recognised that there is a limit to the extent of market borrowing that the central bank can support. these dilemmas can be resolved through proper fiscal monetary coordination. fifthly, the conflict between roles of the regulator / supervisor and as a conductor of the monetary policy has often been discussed. this is illustrated by the case of a central bank, as a monetary authority, which may require to reduce the liquidity in the system by raising the rate of interest. but, such a rise in the rate of interest could be detrimental to the interests of the weak banks. similarly, while tightening prudential norms, the central bank has to take into account its impact on banking systems ’ capacity to intermediate credit. finally, in an open economy, the potential conflict between the interest rate and exchange rate objectives could arise when short - term and volatile capital flows occur. for example, the bouts of volatility in exchange rate experienced by us recently necessitated that market conditions are rendered less liquid even if it meant that the interest rates are kept high. this policy has implications for promoting domestic output growth in that the interest rates may for this purpose, be required to be kept at moderate levels. but the larger objectives of evading the likely potential disruption of domestic activities arising out of an exchange rate crisis should also be kept in view. conclusion as part of financial sector reforms, a number of steps have been taken to enhance the effectiveness of monetary policy, and these include, improvement in the payments and settlement systems, development of secondary market in government securities with a diversification of investor base, reduction in non - performing assets, introduction of alm guidelines, and reduction in the overall transactions costs. in particular, the recent initiatives of rbi to develop