bimal jalan : indian banking and finance - managing new challenges speech by dr bimal jalan, governor of the reserve bank of india, at the banking economists'conference, kolkata, 14 january 2002. * * * introduction in my inaugural address last year, i had indicated a vision for indian banking in the new millennium – that of a vibrant, internationally active banking system, drawing upon its innate strengths and comparative advantages to make india a major banking centre of the world. i had pointed out then that, while it may take up to 10 or even 15 years to achieve this vision, the time to begin was now. recent developments have only served to bring forward the urgency attached to embarking upon this quest. even as we do so, it is necessary to recognise that, in view of recent global developments and the economic slowdown, the progress towards this goal would call for even greater effort and determination. in this context, the theme chosen for this year ’ s conference i. e., “ indian banking : paradigm shift ” is most timely as it provides an opportunity to deliberate on the new challenges ahead, and the action that we must take to manage them. i am happy to be a part of these deliberations and rd to deliver the inaugural address to the 23 conference of bank economists here today. as you are aware, global economic prospects turned sharply adverse since september 2001 following the terrorist attacks on the us. the possibilities of a recovery in the global economy have become highly uncertain, belying the initial expectations of a v - shaped recovery as well as the subsequent hopes of a u - shaped recovery. as of now, the consensus of forecasts settles around 2. 4 per cent for world gdp growth for 2001. world trade volume growth could slow down to around 1. 3 per cent and net capital outflows from developing countries may now be larger than anticipated earlier. although the sharp spurt in international oil prices has abated, their future behaviour remains unclear. macroeconomic weaknesses have also been associated with an erosion of business confidence. insurance, airlines, tourism and hotel industries have been hit hard and the exposure of financial institutions to these industries can be a potential source of vulnerability. despite the relatively inward - looking nature of the indian economy, it cannot remain insulated from these international developments. the direct effects of these external developments on our banking system are expected to be limited. indirect effects, especially through exports and subdued industrial activity could, however, impact upon the asset quality of our banking system and

than in the preceding year. foreign exchange reserves rose to us $ 48. 0 billion as on december 28, 2001 recording an accretion of the order of the us $ 5. 8 billion over the end - march 2001 level. in the context of the recent deceleration in the economy the intermediation role assumes even greater relevance. banks and financial institutions should endeavour to play a ‘ supply - leading ’ rather than ‘ demand - following ’ role in initiating the upturn by energising the financial intermediation process. by virtue of a bird ’ s eye view of the economy and their superior credit assessment of the investment proposals and the efficiency of capital, banks should endeavour to economise on ‘ search ’ costs in identifying and nurturing growth impulses in the commodity and service producing sectors of the economy. in the recent period, monetary policy in india has also moved into a counter - cyclical stance signalled by cuts in key interest rates and cash reserve requirements. at the same time, market operations have ensured adequate liquidity to support the revival of aggregate demand with a clear preference for softening of interest rates within the overall institutional constraints on the interest rate regime. inflation has been steadily falling and this has had a positive impact on inflation expectations, along with the underlying resilience of the macroeconomic fundamentals of the indian economy. the 50 basis point reduction in the bank rate and the 200 basis point reduction in the crr, announced recently, are expected to significantly enhance the lendable resources of the banking system. the current situation of comfortable liquidity provides an opportunity for banks to transform idle liquidity into investible resources for growth. the easy interest rate environment would make it possible for banks to ‘ price in ’ projects which would have earlier remained unfunded due to inherently lower returns to capital or due to lack of access to prime lending rates. this will, however, require reassessment of portfolios and internal liquidity constraints, even adjustments in risk profiles and risk management. the deceleration in the industrial growth scenario, of course, opens up the moral hazard of adverse selection and the possibilities of large - scale contamination of portfolios. in a situation of generalised slowdown, unviable projects can look potentially bankable given the scarcity of investment avenues. nevertheless, the possibilities for financial intermediation in the current situation are too varied and challenging to ignore. there is no systematic evidence that financial sector reforms by themselves and without supportive policies in