rakesh mohan : emerging contours of financial regulation – challenges and dynamics paper by dr rakesh mohan, deputy governor of the reserve bank of india, for the financial stability review of bank of france, 10 june 2009. the assistance of anand sinha, prashant saran, p r ravi mohan, t gopinath, and muneesh kapur in preparation of the paper is gratefully acknowledged. the paper has also benefited from the report of the working group i of the g - 20 on “ enhancing sound regulation and strengthening transparency ”. * * * the world is currently in the midst of the most severe financial and economic crisis since the great depression. although the crisis originated in the sub - prime mortgage market in the united states, it then spread to europe and later to the rest of the world. the speed of the contagion that spread across the world is perhaps unprecedented. what started off as a relatively limited crisis in the us housing mortgage sector turned successively into a widespread banking crisis in the united states and europe, the breakdown of both domestic and international financial markets, and then later into a full blown global economic crisis. almost all governments and central banks of the world have been busy over the last 9 - 18 months in an effort to contain the effects of the crisis through both fiscal and monetary policy measures, respectively. just as the global nature of the crisis is unprecedented, so is the global nature of the response, as exemplified by the coordinated action being committed to by the g - 20. along with the coordinated fiscal and monetary policy actions, a comprehensive reexamination of the financial regulatory and supervisory framework is also underway around the world. against this backdrop, this paper attempts to analyse the emerging contours of regulation of financial institutions with an emphasis on the emerging challenges and dynamics. the paper is organised as follows : section i provides a broad overview of the global developments which contributed to the current global financial crisis. section ii presents the ongoing discussion and debate at the international level in the light of the shortcomings of the extant regulatory framework. section iii analyses proposals for reforming the regulatory framework, while section iv discusses the difficulties in implementing the regulatory proposals. i. evolution of crisis : what went wrong? what are some of the identifiable sources of market failures that led to the current financial turbulence? the current ongoing financial crisis is attributed to a variety of factors such as the developments in the sub - prime mortgage sector, excessive leverage, lax financial regulation and supervision, and

challenge. sixth, as the current global crisis has shown, whereas many of the large complex financial institutions are global in nature, their regulation is national. considerable discussion is now ongoing on how international regulatory cooperation can be enhanced. apart from the regulatory problems associated with ongoing institutions, even more difficult are the problems associated with cross border resolution of failing institutions. the discussion on these issues has just began. seventh, from the point of view of emerging market economies ( emes ), at the macro level, the volatility in capital flows has led to severe problems in both macro management and financial regulation ( cgfs, 2009 ). these capital flows have been influenced significantly by the extant monetary policy regimes in developed countries and hence their volatility is not necessarily related to economic conditions in the receiving economies. excess flows, sudden stops and reversals have significant effects on eme financial sectors, the working of their capital markets, and asset prices, and hence their economies as a whole. management of this volatility involves action in monetary policy, fiscal management, capital account management, and also financial market regulation. this will remain a challenge since there is little international discussion on this issue. finally, in response to the crisis, monetary policy has been loosened substantially in major advanced economies since the second half of 2007. policy rates have been cut to near zero levels, even lower than that in 2003 - 04, and the financial systems have been flooded with large liquidity. abundant liquidity, if not withdrawn quickly, runs the risk of inducing the same excesses and imbalances that were witnessed during 2003 - 07. excess liquidity could also take the form of large capital flows to the emes and their likely recycling back to the advanced economies. as the global economy starts recovery, a calibrated exit from this unprecedented accommodative monetary policy will have to be ensured to avoid the recurrence of the financial crisis being experienced now. to summarise, the emergence of the global financial crisis has led to a new wave of thinking on all issues related to both monetary policy and financial regulation. whereas considerable progress has been achieved on the principles governing this regulatory overhaul, very significant challenges remain on the implementation issues that will arise as we move into a new regime globally. references bank for international settlements ( 2008 ), 78th annual report, 2007 - 08. committee on global financial system ( 2009 ), “ capital flows and emerging market economies ” ( chairman : rakesh mohan ), cgf