kishori j udeshi : bank supervision - challenges ahead na palkhivala memorial oration lecture by ms kishori j udeshi, deputy governor of the reserve bank of india, jaipur, 28 august 2004. * * * i deem it an honour and a privilege to speak before this august gathering on the occasion of the nani palkhivala memorial oration. while conferring on him the honorary degree of doctor of laws, shri nani palkhivala was described by princeton university, usa, as a “ defender of constitutional liberties, champion of human rights, teacher, author and economic developer ”. this description, however, does not capture the brilliance of the man ’ s mind, the eloquence of his speech and the goodness of his heart. while i do not have even an iota of his ability to speak without notes for hours and keep his audience in rapt attention there is one small thing that we two have in common and that is our alma mater ; st. xavier ’ s college, mumbai. shri palkhivala was a director of the central board of the reserve bank of india from 1963 till 1970 and it is befitting that the subject of today ’ s talk is on the challenges ahead for banking. for a better appreciation of the future challenges let me begin by giving a brief glimpse of how we reached where we are today. the financial sector witnessed a radical shift with the introduction of the reform process in 1992. the focus of the reforms was on deregulation and liberalisation especially of the banking sector which is the major component of the financial sector of the country. the banking sector reforms were guided primarily by the recommendations of the committee on financial system ( narasimham committee, 1991 ) which related, among others, to ( a ) reduction in the levels of statutory pre - emptions, ( b ) dismantling the complex structure of administered interest rates, ( c ) laying down of capital adequacy requirements ; ( d ) introduction of prudential norms and ( e ) liberalisation of entry norms for domestic and foreign banks. at the macro level, firstly there has been a reduction in the level of preemption of banks ’ resources. the statutory liquidity ratio ( slr ) has been reduced from 38. 5 percent in 1991 - 92 to 25 percent. the average cash reserve ratio ( crr ) has been reduced from 15 percent in 1991 - 92 to 4.

government - supported institutions brought with them, we should be confident that they should not be allowed to operate in the future as they have in the past. we cannot afford to ignore that through their use of implicit government funding guarantees, they held a significant competitive advantage in the marketplace, and that this in turn encouraged excessive risk on their balance sheets, with tragic outcomes. given past errors, how might we approach the need for some modest support for future financing within the housing industry? i see two basic options. first, if we judge that some public support is needed, we could establish public entities that focus solely on the securitization of conventional, conforming mortgages with strong underwriting standards, tight public oversight and balance sheets limited to holding amounts necessary for warehousing loans to be securitized. this makes the government a conduit only, facilitating the flow of capital but not providing the implicit guarantees on funding and assets held that contributed to this crisis. the market remains the final arbiter of standards and funding. a second option would be to give private entities sole authority to securitize pools of conforming mortgages – similar to what is now done with jumbo mortgages. if the congress was disposed to provide some favor to housing, a federal guarantee could be given to certain securities backed by mortgages meeting strict conforming loan standards. however, such favored status should be based on some limiting factor, such as need or special purpose. either of these two options would address many of the problems associated with fannie and freddie in this crisis and would create a more transparent and competitive marketplace. the latter option involving privately owned entities would offer the additional benefits of greater market discipline and insulation from political influence and control. enforce sound lending standards regardless of these actions, we must as a nation insist on the return to sound real estate lending standards. we know today that countries that avoided the worst of this most recent real estate meltdown did a better and more consistent job in maintaining an effective and consistent set of standards for loan - to - value and debt - to - income ratios. some countries, such as canada, even tightened mortgage lending requirements when real estate markets heated up. in the united states, the opposite occurred. while sound credit standards are a key responsibility of individual lenders, public policy also played an important role in the deterioration of loan quality in the united states. this occurred largely through public efforts to promote and subsidize homeownership and increase access to housing