What next for India's financial sector?
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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