r gandhi : financial stability – issues and concerns : are we barking up all right trees? inaugural speech by mr r gandhi, deputy governor of the reserve bank of india, at the 6th annual great lakes – union bank financial conference, great lakes institute of management, chennai, 5 february 2016. * * * assistance provided by shri r gurumurthy is gratefully acknowledged. 1. it ’ s indeed a pleasure to inaugurate this conference on ‘ financial stability, credit distress and economic growth : the way forward ’ organized under the aegis of the union bank – great lakes center for excellence in banking and finance. i am happy to note that this is a collaborative effort by banking and academic and research institutions. as i will explain, the selected topic of the conference is not just on an apt and very contemporary issue, it also needs theoretical explanation, well researched solutions for practical use by banks. hence, coming together of the three types of entities is very welcome. 2. financial stability objective is, as widely recognised and by very nature, fraught with complexity and challenges in terms of precision in definition, measurement, tools and achievement. though an often quoted and widely used phrase, financial stability has, in contrast to price stability, been difficult to define or measure. from a macroprudential perspective, financial stability could be defined as a situation in which the financial sector provides critical services to the real economy without any discontinuity. however, this cannot be quantified for measurement purposes. 3. as regulators we are expected to indicate and also address the important systemic risk areas, preferably before they materialise, and in a world environment defined by an ever increasing degree of uncertainty, this task continues to get more arduous. while it is important to ‘ bark up ’ ( or shout from the rooftops ) about the systemic risks which, in the opinion of the regulators, are the most significant and more probable, at a given point in time, the regulators cannot afford to miss the woods for the trees. effective regulation thus aims at understanding and guarding against the big risks, going beyond mere compliance with increasingly detailed and complex rules. 4. with this short introduction to the topic, let me set the tone for a post lecture brainstorming amongst you with a few broad themes that i think, underlie the ultimate purpose of my speech. financial stability : a dynamic stability 5. the first one is to revisit the very purpose of the financial system amidst an existential

financial markets are different, and unlike other major jurisdictions, the concerns in this regard mainly relate to a large pool of unregulated small entities with varying activity profiles. thus for us, it is more of a consumer protection issue rather than a systemic stability issue and we have been tackling the same. asset quality in banks 15. is the current emphasis on asset quality of banks a little overstretched undermining other concerns? asset quality is one of the parameters, that define the strength and resilience of the sector ; other factors are soundness ( capital adequacy ), liquidity ( liquid assets to total assets ), profitability and efficiency ( cost to income ). 16. while administering the regulatory medicine, we must be discerning in dealing with asset quality deterioration that is caused by economic / business cycles and for reasons beyond the control of borrowers / entrepreneurs to service their loans from those arising out of wilful delinquencies or over - leveraging. when we are not able to recognise this distinction, the sanctity of official / regulatory ‘ forbearance ’ is undermined by analysts and investors. 17. in our own case, such forbearance in the form of restructured standard advances was granted to ameliorate the impact of worsening economic conditions. what must be appreciated is the fact that restructured advances were disclosed transparently, though we later understood that there is an uncertainty in the markets in reading through these numbers and arriving at what exactly is the quantum of ‘ bad apples ’ in the banking sector basket. it is to put an end to such speculation about the asset quality issues, good governance required us to take the ‘ asset quality review ’ on a priority basis so that all stakeholders can clearly see the strength of the banks ’ balance sheets. 18. resolving asset quality issues in psbs also has become little urgent ahead of plans for capital augmentation under the new dispensation, if we take into account the behavioural dimension, as both lenders and borrowers tend to be drawn towards taking extreme positions bis central bankers ’ speeches between ‘ total risk aversion ’ and ‘ the temptation to take bigger gambles ’ in the face of potentially weaker balance sheets. issues beyond asset quality 19. we need also to look at issues other than the quality of assets in banks, that include autonomy to take commercial decisions to governance structures, especially where the board level responsibilities should go beyond ‘ box - ticking ’