. commercial banks in india are expected to start implementing basel ii with effect from march 31, 2007 though a marginal stretching is not ruled out in view of the state of preparedness. they will initially adopt standardised approach for credit risk and basic indicator approach for operational risk. after adequate skills are developed, both at the banks and also at supervisory levels, some banks may be allowed to migrate to the internal rating based ( irb ) approach. under basel ii, indian banks will require larger capital mainly due to capital required for operational risk. the rbi has introduced capital instruments both in tier i and tier ii available in other jurisdictions. in addition, the rbi is involved in capacity building for ensuring the regulator ’ s ability for identifying and permitting eligible banks to adopt irb / advanced measurement approaches. the sixth aspect is the role of capital in case of regional rural banks ( rrbs ) and cooperative banks, which provide banking services primarily in the rural and semi - urban areas. the problems with regard to this segment have been widely documented : these include constraints on timely credit availability, its high cost, neglect of small farmers and continued presence of informal lenders. it is argued that most part of the cooperative credit structure is multi - layered, undercapitalised, over - staffed and underskilled, often with high level of delinquent loans. the rrbs also appear to share these problems, although there are several viable institutions in this category. these are being addressed on a priority basis. a national - level committee had recently made recommendations to revive and restructure the rural cooperative credit structure. these have been accepted by the government which has set up a national level implementation and monitoring committee under the chairmanship of the governor for overall guidance in implementation. a process of revitalising rrbs and urban cooperative banks in a medium - term framework is also underway. seventh, we are adopting a three - track approach with regard to capital adequacy rules. on the first track, the commercial banks are required to maintain capital for both credit and market risks as per basel i framework ; cooperative banks on the second track are required to maintain capital for credit risk as per basel i framework and surrogates for market risk ; rrbs on the third track which though subject to prudential norms do not have capital requirement on par with the basel i framework. in other words, a major segment of systemic importance is under a full basel i framework, a portion of the minor segment partly on basel i framework and

capricious ways. eme central banks have to deepen their understanding of these interactions. some of the channels through which cross - border transmission occurs are quite familiar – global prices, including commodity price movements ; synchronization of business cycles ; capital flows ; strong comovement of asset prices ; exchange rates of key international currencies ; and interest rate policies of central banks. some of the transmission channels are less familiar. for example, the crisis has shown that even differences in regulatory regimes can trigger arbitrage - based action and dilute the efficacy of domestic policies. impossible trinity 18. the best way to understand the challenge of monetary policy formulation in a globalizing world is through the “ impossible trinity ” trilemma. this trilemma asserts that a country cannot simultaneously maintain all three policy goals of free capital flows, a fixed exchange rate and an independent monetary policy. 19. given the “ impossible trinity ” trilemma, countries have made different choices. the most common choice, typical across advanced economies, is to give up on a fixed exchange rate so as to run an open economy with an independent monetary policy. on the other hand, economies that adopt a hard peg give up on the independence of monetary policy. examples include the currency boards set up by hong kong and, for a time, argentina. 20. in contrast to advanced economies which opt for corner solutions, emerging economies here typically opted for middle solutions, giving up on some flexibility on each of the variables to maximize overall macroeconomic advantage. india ’ s approach to the impossible trinity 21. in india too, we have opted for a middle solution on the “ impossible trinity ” whose contours are the following : ( i ) we let our exchange rate be largely market determined, but intervene in the market to smooth excess volatility and / or to prevent disruptions to macroeconomic stability ; ( ii ) our capital account is only partly open ; while foreigners enjoy mostly unfettered access to our equity markets, access to debt markets is restricted ; there are limits to the quantum of funds resident corporates and individuals can take out for investment abroad, but the limits are quite liberal ; and ( iii ) because of the liberalization on the exchange rate and capital account fronts, some monetary policy independence is forfeited. what the middle solution also implies is that we have to guard on all the three fronts with the relative emphasis across the three pillars shifting according to our macroeconomic situation. managing capital flows 22. what