Questions: 1. What causes financial instability? 2. How can RBI deal with financial instability? 3.

Trade-off between financial stability and growth?

Reasons for financial instability Increased non-official capital flows across countries through banks and international capital markets. Hasty and non-strategic liberalisation Deregulation of financial sector Opening up of the capital account in many countries

Intiatives by RBI Had set up the Committee on Financial Sector Assessment in 2009 Will setup a dedicated interdisciplinary Financial Stability Unit with the remit to assess the health of the financial system with a focus on identify and analysing potential risks to systemic stability and carrying out stress tests on an ongoing basis Financial Stability Reports are being released

Financial Stability Report Three FSRs released till June 2011 First was released in March 2010 As per the three FSRs released so far, there is no serious threat to the Indian financial system FSR 2011 o states that the Indian financial system remains stable in the face of some fragilities being observed in the global macro-financial environment. o Banking sector continues to be stable o Banking stability indicator confirms the overall improvement in the stability of banking sector o Toxity index/vulnerability index: the probability of a bank causing distress to another bank or being affected by the distress of another bank o

FS in India The relatively crisis free environment in the Indian financial system can be attributed to the strength of state home grown policies pursued with caution and prudence. In the late 1990s, FS was incorporated as a specific objective of the RBIs policy after the Asian Financial crisis. Present weaknesses in the financial system o Greater access of domestic corporate to ECBs has resulted in increased currency mismatches

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Increased reliance on market borrowings could adversely affect the liquidity position of banks There remains gaps in the regulatory framework for NBFCs