reform measures aim to tighten capital requirements, both in terms of quantity and quality. the significant enhancements made to the original basel ii framework will lead to a new set of rules that has therefore rightly been termed basel iii. after the promising consensus achieved at the summit in seoul, the task is now to transpose the g20 agreement into national law. of course, the increased requirements are associated with adjustment costs for financial institutions. yet, a number of studies have been conducted. the investigations have shown these costs to be manageable, not least due to the lengthy transition phase that will attenuate the adaptation process. even the distinctive features of the tripartite german financial system have been taken into due consideration. the sector ’ s profitability will probably decrease, yet so will fluctuations, thereby supporting continuous growth. impacts on cost of credit and thus on the real economy will, however, be limited. fears of dire consequences therefore appear exaggerated, and banks should instead embark on the task of adjusting to the new requirements at an early stage. however, the increased risk buffer in the shape of higher capital requirements is no panacea. it is a central lesson from the crisis that a second line of defence is needed to prevent individual banks that still fail from triggering a systemic crisis. this issue is particularly acute in the case of systemically important financial institutions ( sifis ). the discussion of how best to treat them is still ongoing, but the contours of the future framework are taking shape now that the g20 summit has endorsed the fsb ’ s sifi recommendations : a core policy instrument are resolution regimes that are tailored to the particularities of the financial system and that allow to resolve even systemic financial institutions without endangering the functioning of the financial system. higher capital requirements in a variety of forms are a suitable instrument to increase the loss absorption capability of sifis and, at the same time, to counter moral hazard by pricing in their externalities. however, important details of these sifi recommendations and corresponding policy measures still need to be agreed on, and some questions remain unanswered. one important issue is how to measure systemic relevance and how to translate this into regulatory and supervisory action. the crisis has also demonstrated that systemic risks have been shifted out of the regular and therefore regulated banking sector into the so called shadow banking system. this underlines just how important it is to complement traditional microprudential institutional supervision by macroprudential oversight. yet for this new

and use derivative products for asset - liability management. these activities are subject to net overnight position limit and gap limits, to be fixed by them. other measures such as permitting forward cover for some participants, and the development of the rupee - forex swap markets also have provided additional instruments to hedge risks and help reduce exchange rate volatility. alongside the introduction of new instruments ( cross - currency options, interest rates and currency swaps, caps / collars and forward rate agreements ), efforts were made to develop the forward market and ensure orderly conditions. foreign institutional investors were allowed entry into forward markets and exporters have been permitted to retain a progressively increasing proportion of their earnings in foreign currency accounts. the rbi conducts purchase and sale operations in the forex market to even out excess volatility. in respect of the financial markets, linkage between the money, government securities and forex markets has been established and is growing. the price discovery in the primary market is more credible than before and secondary markets have acquired greater depth and liquidity. the number of instruments and participants in the markets has increased in all markets, the most impressive being the government securities market. the institutional and technological infrastructures that have been created by the rbi to enable transparency in operations and secured settlement systems. the presence of foreign institutional investors has strengthened the integration between the domestic and international capital markets. credit delivery the reforms have accorded greater flexibility to banks to determine both the volume and terms of lending. the rbi has moved away from microregulation of credit to macro management. external constraints to the banking system in terms of the statutory premptions have been lowered. all this has meant greater lendable resources at the disposal of banks. the movement towards competitive and deregulated interest rate regime on the lending side has been completed with linking of all lending rates to plr of the concerned bank and the plr itself has been transformed into a benchmark rate. as a result of reforms, borrowers are able to the get credit at lower interest rates. the lending rate between 1991 - 92 and 2001 - 02 has declined from about 19. 0 per cent to current levels of 10. 5 - 11. 0 per cent. the actual lending rates for top rated borrowers could even be lower since banks are permitted to lend at below prime lending rate ( plr ). further, since banks invest in commercial paper ( cp ), which is more directly related to money market rates, many top rated borrowers are able to