What Next For India'S Financial Sector?
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What next for India's financial sector?

Database Administrator

For the financial sector to serve the real sector, yesterday's beliefs offer no road map for tomorrow's policy options.

Did policy save India?

Some say India has been saved from the financial crisis only because the policy was conservative and did not act to improve the efficiency of the system. Hence, their prescription is to act now on efficiency. This view is not right because India was active in policy interventions in both monetary and financial sectors. RBI adopted an active countercyclical policy, while many others failed to intervene. There is another problem with acting rapidly or comprehensively on reform -- there is no agreement on a right model for financial sector reforms.

What is good for tomorrow

It is, therefore, desirable to look carefully and pragmatically at specific and urgent issues that need attention and not proceed with what I would call yesterday's beliefs on what is good for tomorrow.

There are several inadequacies in our financial system, ranging from credit-culture to financial exclusion and poor service. Serious infirmities that could cause a crisis may not exist in our system, but the financial sector is yet to fully serve the needs of the real sector. The needs of the real sector can be met only when there are synchronised reforms in both real and financial sectors.

These questions are:

(1) Is macroeconomic management reasonably balanced? The answer is obviously yes -- by and large. We have no excessive current account surplus or deficit; no excessive dependence on exports or external demand; no excessive reliance on investment or consumption expenditure; and, no excessive leverage in most households or corporate houses or financial intermediaries.

We are, however, vulnerable to shocks on four fronts: fuel, food, fiscal and finance -- external. In regard to fiscal, the quality of management and subordination of monetary policy continue to be issues. On the external sector, the quality of capital flows will continue to be an area of concern.

(2) Is monetary policy sound and well-equipped? The answer is yes, by and large.

(3) Are there suitable mechanisms for regulatory coordination in the financial sector? The answer is broadly yes, but with some scope for improvement.

(4) Are there incentive systems that are inappropriate for stability of the financial system and the interests of depositors or investors? Perhaps a systematic study may be needed on this before we make any conclusions.

(5) Is there evidence of conflicts of interests in the financial sector? This is another area in which study is needed to make an assessment.

(6) Is there evidence of excessive financialisation? Excessive financialisation may be occurring due to the proclivities of financial markets and institutions to multiplicity of transactions since they obtain incomes through margins on trading. Generally speaking, when multiplicity in financial transactions take place with no visible signs of redistributing risk or more efficiently reallocating resources, it amounts to excessive financialisation.

(7) Is there any evidence of irresponsible lending, like the subprime in the US? There is no direct evidence of any large-scale lending in India that could be characterised as irresponsible lending. But, a study should be made of commercial banks' lending and support to micro-finance institutions, which are profit-seeking (MFI-PS).

(8) Are there any concerns relating to the integrity of financial markets?

(9) Is the banking system sound, resilient, efficient and performing the functions expected of the system?

India, like many developing economies, has a bank-dominated financial system. There is a broad agreement about the strength and resilience of banks in India, while there are debates on the level of efficiency in the context of externally imposed policy constraints and governance standards. However, we have to assess whether there is hollowness in the provision of banking services in our country. I am not referring to the issue of financial inclusion or efficiency of customer service, though both are important and need attention. I refer to the main functions of a bank, namely, taking deposits and providing credit.

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