reserve to regulate all institutions of systemic importance. in order to put a control on the burgeoning shadow banking activities, the european union has also put in place some measures, which inter alia include prudential rules concerning securitisation, regulation of credit rating agencies, etc. further, at the request of g - 20 countries, at international level, fsb has been working towards strengthening the oversight and regulation of the shadow banking system so that the risks emanating from them may be mitigated. various other countries, including india are working towards improving the regulatory framework so as to curb the shadow banking activities, which pose a risk to financial stability. challenges posed by shadow banks 10. though the focus of regulation on shadow banking activities emerged in the wake of their alleged role in the recent global crisis, shadow banking system is not a new development. even in the late 1950s and early 1960s, concerns emanating from the growth of non - bank financial intermediaries had been highlighted [ thorn ( 1957 ) ; hogan ( 1960 ) ]. thorn ( 1957 ) had advocated same degree of control over credit expansion by the nbfis as that of the banks. hogan ( 1960 ) found that from late 1930s to 1950s, while the role of banking system in australia was declining, that of the financial intermediaries was rising and he called for controlling the liquidity of the non - banking sector. 11. the biggest challenge for the regulators is to gauge the magnitude of shadow banking as this landscape is continually evolving by arbitraging the gaps in the regulatory framework that otherwise seek to control them. furthermore, unlike the banking sector, which have a very good statistical coverage, consistent database on shadow banking is not available given the heterogeneous nature of shadow banking entities, instruments and activities. 12. some of the challenges posed by the shadow banks to the global economy and economies, in general, are as follows : a. financial stability and systemic risk concerns 13. across various economies, regulatory arbitrage was used to create shadow banking entities. in many instances, banks themselves composed part of the shadow banking chain by floating a specialized subsidiary to carry out shadow banking activities. banks also invested in financial products issued by other shadow banking entities. since shadow bank entities have no access to central bank funding or safety nets like deposit insurance, they remain vulnerable to shocks. given the huge size of shadow bank activities and their interlinkages with other entities of the financial sector, any shock in the

, is likely to pose other threats / challenges to some economies. some of these issues are procyclicality, herding behaviour, likely adverse impact on emerging market economies. basel ii challenges i would now like to discuss some of the challenges which we have faced in our journey to basel ii implementation and how we have attempted to address these challenges. i am sure the regulators in other jurisdictions would also have faced similar issues and they would have devised their own strategies for addressing them. as a part of the consultative process and with a view to ensuring smooth migration to the new framework, we have constituted a ‘ steering committee ’ comprising of representatives from fourteen select private sector banks, public sector banks and foreign banks, the indian banks ’ association and the reserve bank of india. the steering committee has examined various issues of the basel ii framework and made its recommendations to the reserve bank for consideration. hence, we might say that the banks and the reserve bank have worked together to address the challenges. some of these are discussed below : a ) which level / approach? when basel ii framework was being finalized and even soon after its finalization the general indications were that many banks in major jurisdictions would aim at implementing internal ratings based approach ( irba ) for credit risk and advanced measurement approach ( ama ) for operational risk straightaway. it would be seen that the main incentive for this stance might have been that adoption of irba / ama would reduce the capital requirements for banks and thus, enable them to achieve better capital efficiency. this stance of the banks / regulators in other jurisdictions seemed to put some pressure on banks in india also to adopt irba / ama directly. there were some thoughts in some quarters that if the banks in india do not adopt irba / ama, they run the risk of being viewed as inferior banks and consequently the system might be branded as a secondary citizen in the global financial markets. as mentioned earlier, our approach to reforms has been to align with the international best practices but adopt them in a manner and pace as suitable to our economy and environment. therefore, we have consciously decided to mandate the standardized approach and basic indicator approach to all scheduled commercial banks in india as the first step in migration to basel ii. we also observe that as compared to the initial indication, the number of international banks which are looking to directly adopt irba / ama at the first instance has reduced. many jurisdictions require only a few banks to adopt irba / ama while all the other banks would be on the simpler approaches.