a more competitive environment in the financial sector through reform measures such as relaxation of entry and exit norms, reduction in public ownership in the banking industry and letting banks access the capital market in order to meet their funding requirements. the objective is to bring out the best result in terms of pricing and quality of banking services over a period of time. the third important direction of reform has been the strengthening of market institutions and allowing greater freedom to financial intermediaries. these reforms have taken the form of gradual liberalisation of interest rates, development of money, capital and debt markets and giving operational flexibility to banks in the management of their assets and liabilities subject, of course, to prudential guidelines. in simple terms, these changes imply a greater degree of exposure of individual financial institutions to the domestic and international economic environment. in this connection, a distinction needs to be made between two types of market developments, which have implications for the financial system. one is developments in respect of macroeconomic fundamentals of the economy which impact on the interest rate, exchange rate and other asset prices. this is a normal phenomenon in any economy and has implications for the balance sheets of the financial intermediaries. institutions which do not have an organised approach in anticipating events, undertaking pre - emptive actions and designing a suitable response to unanticipated developments can find themselves in a difficult situation, particularly in times of a large degree of fluctuations in macroeconomic variables. the dangers posed by market and credit risks arising out of macroeconomic shocks need to be given special attention in a liberalised financial system. our reform initiatives in this area are still in the formative stage. the second type of market developments which have implications for the financial sector relates to asset price bubbles, which may be related to a high concentration of bank lending to one or two sectors which have a boom and bust cycle of their own. this form of market exposure can be unhealthy and lead to irreparable shocks. although the impact of such cycles on our banking system is quite limited, international experience suggests that, unless prudential measures are in place, banks can be potentially vulnerable to asset price pressures that can generate systemic risks for the financial system. the fourth important element of reform concerns the “ safety ” aspects of the financial system. this is the core of the challenges facing the financial system at present. when the reform process was started in 1992, there was a massive problem of cleaning the balance sheets of banks which had deteriorated over the years

in order to avoid term mismatches in portfolios. a proper cushion needs to be kept by way of capital reserves against market exposure and capital size should set a limit for the risk exposure of an individual financial institution. apart from capital adequacy standards, the new international norms of banking regulation and supervision require a more proactive role for the regulator in enforcing an effective mechanism for evaluating, monitoring and managing risks in the financial system. this in turn would need stricter accounting, valuation and reporting norms on the part of banks. the basle core principles have also identified a number of challenging areas for regulators and supervisors, which must be satisfied to ensure orderly conduct of financial system and to promote its soundness and stability. transparency in banking operation is also something which has to receive top priority given the current nature of capital markets. transparency and accountability demand realistic valuation of assets, public disclosure norms and prudential reporting by banks to help depositors and investors form an informed opinion about the state of the financial system, thereby enabling them to react in an orderly fashion to asset price changes. moreover, public intervention policies in the form of explicit or implicit guarantees may have to be such that they do not lead to “ moral hazard ” in the form of undue risk - taking by banks and laxity in observing market disciplines. india must remain in the forefront of the movement for ensuring soundness of the banking system by adopting best practices and best international standards of performance and prudence. actions have already been initiated in this direction. the challenge now is to accelerate this process so that the banking and the financial system in our country can contribute to the sustained growth of the real economy with price stability. role of bank economists before i conclude, let me say a word about the role of bank economists in facilitating the reform process. this annual conference is a testimony to the economic talent that our banking system has developed over the years. almost all our banks have economic research departments or economic cells which are staffed by highly qualified economists with long experience in banking and the financial sector. the issue that i would like to pose before this conference is : are we making the best and most effective use of economists working in the banking sector to improve the functioning of banks, and for that matter, the operational efficiency of the financial sector as a whole? in commercial organisations like banks, economics departments have the advantage of not being excessively burdened with day - to - day problems of running the banks or ensuring the safety and profitability of individual