Reasons for Financial Instability, Initiatives by RBI, Financial Stability Report

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  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

Initiatives 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
  • States that the Indian financial system remains stable in the face of some fragilities being observed in the global macro-financial environment.
  • Banking sector continues to be stable
  • Banking stability indicator confirms the overall improvement in the stability of banking sector
  • Toxity index/vulnerability index: the probability of a bank causing distress to another bank or being affected by the distress of another bank

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 RBI՚s policy after the Asian Financial crisis.
  • Present weaknesses in the financial system
    • Greater access of domestic corporate to ECBs has resulted in increased currency mismatches
    • Increased reliance on market borrowings could adversely affect the liquidity position of banks
    • There remains gaps in the regulatory framework for NBFCs

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