changed in a significant way drawing lessons from the crisis. before i expound on the revamped approach to regulation and supervision in the post crisis world, let me step back a little and briefly touch upon the genesis of crisis. this not only helps in putting things in perspective, but as we deliberate on the reasons underlying the crisis, the solutions would automatically flow. the genesis several factors were responsible for the crisis. however, at the core of the crisis was the inadequate understanding and measurement of risks and funding of assets with shorter term liabilities on a large scale. there was aggressive easing of monetary policy in the us after the bursting of dotcom bubble leading to very low interest rates. the long term yields in the us were also depressed on the back of global imbalances as the huge reserves built by bis central bankers ’ speeches countries, specifically china, found their way back to the us treasuries. an era of great moderation followed : there was steady growth in advanced economies and accelerated growth in emerging market economies along with low and stable inflation. this resulted in policy makers believing that they had found the holy grail of high growth with low inflation. underlying this belief was the notion that markets had become mature and sophisticated and had the wherewithal to distribute risks and provide efficient hedging instruments to those who needed. low interest rates triggered a massive search for yield which led to financial innovation that was socially suboptimal. the innovation was aided by the progress in quantitative finance and modelling and technological developments. while we cannot disregard the utility of financial models – they are certainly very useful – overreliance on such models proved to be disastrous. the financial models, in contrast with the models used in physics, are not governed by immutable laws of nature but by the human behaviour – the herd mentality, irrational exuberance and pessimism, greed and fear, which cannot be modelled with any accuracy. hence, these limitations need to be factored in while using the models. low interest rates prior to the crisis enabled build up of leverage. in fact, if we observe closely, leverage happens to be the major contributing factor to most crises. let me explain in brief. when times are good, there is a feel good factor, there is plenty of liquidity which is cheap, the asset values and collateral values are high and the banking system losses are low, leading to lower provisioning and lower capital requirements. these factors lead to higher demand for credit from the households

anand sinha : approach to regulation and supervision in the post crisis world keynote address by mr anand sinha, deputy governor of the reserve bank of india, at the program “ supervisory effectiveness in the post crisis world ”, organized by the centre for advanced financial research and learning ( cafral ), mumbai, 4 february 2013. * * * inputs provided by ajay kumar choudhary, ms. anupam sonal rajnish kumar and jayakumar yarasi are gratefully acknowledged. ms. usha thorat, director, centre for advanced financial research and learning ( cafral ), mr. aristobulo de juan, a veteran supervisor and an international consultant, mr. pierre yves thoraval, former deputy secretary general of the french banking commission, mr. chris cardoza, program director at the toronto centre, ms. shyamala gopinath, former deputy governor, reserve bank of india and all the esteemed delegates of the conference. it is my privilege to address you all in this conference today. the conference is quite aptly themed “ supervisory effectiveness in the post crisis world ”. the policy makers and supervisors are trying to grapple with the havoc the crisis has wreaked. so much ink has been spilt and so many reams of papers have been used in describing the what, why and how of the crisis. new regulations have replaced old ones and new theories have come to the forefront debunking the old and crisis - battered beliefs. but one question still remains. have we really come out of the crisis and entered the post - crisis world? is the crisis now a thing of the past and is it firmly behind us? it does not appear to be so. if one looks at the latest imf update on world economic outlook ( weo - jan 2013 ), the growth rates have been revised downwards, though marginally, to 3. 5 % for 2013 and 4. 1 % for 2014 and it specifically notes that the euro area continues to pose a large downside risk to the world economy. if we look at the history of financial crises, they have never been far away. the earliest recorded crisis dates back to 13th century when there was a default by england. we have had so many crises in the more recent past such as, great depression of 1929, stock market crash of 1987, asian crisis of 1997, banking crises in several countries in 80s and 90s and the dot com bubble of 2000, etc.,