models of financial crises and reforms in the

8/14/2019 Models of Financial Crises and Reforms in The

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Models of Financial Crises, Reforms in theModels of Financial Crises, Reforms in the

International Financial Architecture andInternational Financial Architecture and

Determinants of Financial Crisis in India fromDeterminants of Financial Crisis in India from

1971-72 through 2008-091971-72 through 2008-09

S.K.Mathur,PhDS.K.Mathur,PhD

AP,HSS,IITK(www.iitk.ac.in)AP,HSS,IITK(www.iitk.ac.in)


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Definition of Crises andDefinition of Crises and

LinksLinks Sachs(1997) classified financial crises as fiscal crises,Sachs(1997) classified financial crises as fiscal crises,exchange crises( currency crisis and currency crashes)exchange crises( currency crisis and currency crashes)and banking crises according to their field. First a fiscaland banking crises according to their field. First a fiscalcrisis means the situation where the government getscrisis means the situation where the government gets

into debt restructuring or default as it cannot postponeinto debt restructuring or default as it cannot postponea debt or get a new loan. Second, an exchange crisisa debt or get a new loan. Second, an exchange crisismeans depletion of the central banks foreignmeans depletion of the central banks foreignexchange reserves as market participants switchexchange reserves as market participants switchdomestic currency denominated assets into foreigndomestic currency denominated assets into foreigncurrency denominated assets. Lastly a banking crisiscurrency denominated assets. Lastly a banking crisis

hits the commercial banks when they face liquidityhits the commercial banks when they face liquidityshortage or insolvency as they cannot roll over debtshortage or insolvency as they cannot roll over debtany longer or face a sudden withdrawal of deposits.any longer or face a sudden withdrawal of deposits.


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Links between CrisesLinks between Crises

Banking Crisis can cause a CurrencyBanking Crisis can cause a CurrencyCrisis( Interventions to increase credit can lead toCrisis( Interventions to increase credit can lead to

inflation and devaluation of currency)inflation and devaluation of currency)

Currency Crisis can cause Banking Crisis( throughCurrency Crisis can cause Banking Crisis( throughdecrease in reserves and credit (money supply) anddecrease in reserves and credit (money supply) and

commercial banks have to give up loans even tocommercial banks have to give up loans even to

profitable entitiesprofitable entities

Sudden Capital Outflows can cause a banking crisisSudden Capital Outflows can cause a banking crisisand a currency crisis(IMF,1997).and a currency crisis(IMF,1997).


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Impact of Financial CrisesImpact of Financial Crises

A collapse in housing prices in the United States in the middle of 2007 led to a rise in defaults in loan repaymentsA collapse in housing prices in the United States in the middle of 2007 led to a rise in defaults in loan repaymentsand then rapidly to major losses in financial institutions ACROSS THE WORLD. Contagion Effect prevalent.and then rapidly to major losses in financial institutions ACROSS THE WORLD. Contagion Effect prevalent.Governments and Central Banks are now rethinking about the organizational structure and the incentives givenGovernments and Central Banks are now rethinking about the organizational structure and the incentives givento executives to promote profits at all costs. Reasons ranging from moral hazard( on part of investment bankers),to executives to promote profits at all costs. Reasons ranging from moral hazard( on part of investment bankers),adverse selection (of borrowers of mortgage loans), global financial imbalances and low interest rate, monetaryadverse selection (of borrowers of mortgage loans), global financial imbalances and low interest rate, monetarypolicy of the US after dot com trouble in 2001, inadequate regulation of investment banks( forays into capitalpolicy of the US after dot com trouble in 2001, inadequate regulation of investment banks( forays into capitalmarkets), Chinese undervalued exchange rate.markets), Chinese undervalued exchange rate.

Five independent investment banks disappeared during the recent US sub prime lending crisis; two wentFive independent investment banks disappeared during the recent US sub prime lending crisis; two wentbankrupt, one was taken over by the commercial bank and two converted into financial conglomerates. Shadowbankrupt, one was taken over by the commercial bank and two converted into financial conglomerates. Shadow

Banking system at fault. US States Nevada and California affected the most. 40% reduction in stock value. Loss ofBanking system at fault. US States Nevada and California affected the most. 40% reduction in stock value. Loss ofMore than 6 lakhs jobs in California from 2007(total 7 million job lost). Unemployment rate 12.5%(short of 20%More than 6 lakhs jobs in California from 2007(total 7 million job lost). Unemployment rate 12.5%(short of 20%figure during the great depression, 1929). US fiscal stimulus 5.6% of GDP.figure during the great depression, 1929). US fiscal stimulus 5.6% of GDP.

In India stock prices declined by 40%, exchange rate declined by 25%, loss of reserves about 40-50 billion inIn India stock prices declined by 40%, exchange rate declined by 25%, loss of reserves about 40-50 billion inreserves in two months, tightening of credit lines abroad led indian firms to turn to indian banking system forreserves in two months, tightening of credit lines abroad led indian firms to turn to indian banking system forcredit and demand for foreign exchangecredit and demand for foreign exchange

$ 150 billion moved out of the 5 East Asian Countries which the World Bank Defined as the East Asian Tigers in$ 150 billion moved out of the 5 East Asian Countries which the World Bank Defined as the East Asian Tigers inthe month of June 1997 leading to deceleration in economic growth rates and heavy depreciation of thethe month of June 1997 leading to deceleration in economic growth rates and heavy depreciation of theexchange rate( currency crashes). Contagion effect prevalent. Non banking institution lacked supervision for theirexchange rate( currency crashes). Contagion effect prevalent. Non banking institution lacked supervision for theirlending for real estate, margin loans for equity, consumer finance and equity finance.lending for real estate, margin loans for equity, consumer finance and equity finance.

Probably more of such crisis in future because of risk taking behaviour of market players for increasing growthProbably more of such crisis in future because of risk taking behaviour of market players for increasing growthand forays into rural areas in India. Need to have correct diagnose and resolution at national, regional andand forays into rural areas in India. Need to have correct diagnose and resolution at national, regional andinternational level (international financial architecture)international level (international financial architecture)


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Financial Crisis and FactorsLeading to Crisis

Financial Crisis is a regular phenomena of the 20 the CenturyFinancial Crisis is a regular phenomena of the 20 the Century(Kaminsky and Reinhart,1999),Important ones: Latin America(Kaminsky and Reinhart,1999),Important ones: Latin AmericaCrisis(1982, petro dollars available), EMU Crisis(1992), MexicanCrisis(1982, petro dollars available), EMU Crisis(1992), MexicanPeso Crisis(1994, CAD/GDP 8%), East Asian(1997), ArgentinianPeso Crisis(1994, CAD/GDP 8%), East Asian(1997), ArgentinianCrisis(2001), Turkey(2000, sale of government securities by banksCrisis(2001), Turkey(2000, sale of government securities by banks

triggered action by creditors),Russian(1998) among others, Indiatriggered action by creditors),Russian(1998) among others, India(1991, mortgage gold abroad to borrow) more than 150 episodes(1991, mortgage gold abroad to borrow) more than 150 episodesof banking and currency crisis since 1970s. Precise figures 124of banking and currency crisis since 1970s. Precise figures 124banking crisis, 208 currency crisis and 63 sovereign debtbanking crisis, 208 currency crisis and 63 sovereign debtcrisis(IMF,2008) Fiscal cost ranging from 3% to 20 % of the GDP.crisis(IMF,2008) Fiscal cost ranging from 3% to 20 % of the GDP.18 bank centered financial crisis from post war period (Reinhart18 bank centered financial crisis from post war period (Reinhartand Rogoff, 2008)and Rogoff, 2008)

While each financial crisis is distinct they also share strikingsimilarities in the run up of asset prices, in debt accumulation, ingrowth patterns, in current account deficit (Boom and BustPhenomena, V shaped), Reinhart and Rogoff(2008)


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Impact on India

Key Macro IndicatorsIndicator Period 2007-08 2008-09

Growth, per cent

Real GDP Growth April-December 9.0 6.9

Industrial

production

April-February 8.8 2.8

Services April-December 10.5 9.7

Exports April-March 28.4 6.4

Imports April-March 40.2 17.9

GFD/GDP April-March 2.7 6.0

Stock Market(BSE Sensex)

April-March 16,569 12,366

Rs.per US$ April-March 40.24 45.92


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Models of Financial CrisesModels of Financial Crises

Krugman(1979) Model of Macroeconomic ImbalancesKrugman(1979) Model of Macroeconomic ImbalancesCreated through high fiscal deficit and inadequateCreated through high fiscal deficit and inadequatereserves (First Generation)reserves (First Generation)

Self Fulfilling Models by Radelet and Sachs(1998),Self Fulfilling Models by Radelet and Sachs(1998),

Obstfield(1996), Ozkan and Sutherland(1995),Obstfield(1996), Ozkan and Sutherland(1995),Wyplosz(1998): Second Generation ModelsWyplosz(1998): Second Generation Models

Models Of Moral Hazard and Adverse Selection byModels Of Moral Hazard and Adverse Selection byKrugman(1998), Dooley(1997), Radelet andKrugman(1998), Dooley(1997), Radelet andSachs(1998):Third Generation. US Subprime crisis due toSachs(1998):Third Generation. US Subprime crisis due tomoral hazard( role of credit agencies and complex andmoral hazard( role of credit agencies and complex and

toxic assets not priced accurately) and adverse selectiontoxic assets not priced accurately) and adverse selection Fourth Generation Models By Bhagwati(1998) andFourth Generation Models By Bhagwati(1998) andRadelet and Sachs(1998):Creditors ActionsRadelet and Sachs(1998):Creditors Actions


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Reasons of Financial CrisesReasons of Financial Crises

Macroeconomic imbalances( inflation, budget deficit, government debt, interest rates)Macroeconomic imbalances( inflation, budget deficit, government debt, interest rates)financial instability (markets, Institutions, infrastructure:Mathur,2003), and Microeconomicfinancial instability (markets, Institutions, infrastructure:Mathur,2003), and MicroeconomicImbalances/ Instability( how are banks generating and investing funds, borrow short andImbalances/ Instability( how are banks generating and investing funds, borrow short andinvest long, corporate governance issues, hedging instruments leading to speculation)invest long, corporate governance issues, hedging instruments leading to speculation)

Speculation and Self Fulfilling TendenciesSpeculation and Self Fulfilling Tendencies Moral Hazard and Adverse SelectionMoral Hazard and Adverse Selection Creditors actionsCreditors actions

Investment Banks( underwriters and price determination of new stocks) in the US sold toxicInvestment Banks( underwriters and price determination of new stocks) in the US sold toxicassets with perverse incentives( including innovations in derivative instruments) with theassets with perverse incentives( including innovations in derivative instruments) with thehope that investors will buy them by making available easy funds through sub prime loans.hope that investors will buy them by making available easy funds through sub prime loans.Decline in housing prices made the whole investments in mortgage based (loans) securitiesDecline in housing prices made the whole investments in mortgage based (loans) securitiesunprofitable leading to bursting of the asset bubble( deceleration of asset prices) and henceunprofitable leading to bursting of the asset bubble( deceleration of asset prices) and henceshortage of liquidity and capital in the banking system first and then in the entire system.shortage of liquidity and capital in the banking system first and then in the entire system.Interlinkages in financial markets compounded the problem( global supervisory andInterlinkages in financial markets compounded the problem( global supervisory andregulatory standards required).regulatory standards required).

Global Financial Imbalances, Nth Country Problem, Impossible Trillema between MonetaryGlobal Financial Imbalances, Nth Country Problem, Impossible Trillema between Monetaryindependence, perfect capital mobility and fixed exchange rate system, Exchange Rateindependence, perfect capital mobility and fixed exchange rate system, Exchange RateDistortions, Monetary Policy Volatility( low interest since the dot.com trouble in the US)Distortions, Monetary Policy Volatility( low interest since the dot.com trouble in the US)

Factor Accumulation leading to Diminishing marginal ProductivityFactor Accumulation leading to Diminishing marginal Productivity


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Global Financial CrisisUS Monetary Policy

Volatility in monetary policy in advanced economies

Large volatility in capital flows to EMEs

Again very loose MP in US likely surge in capital flows to EMEs?


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o a nanc a r s sUS Monetary Policy

Taylors rule which determines nominal interest rate as a function ofdifferences in actual and target inflation rates and growth rates and potential

growth rate

US Monetary policy too loose during 2002-04; aggregate

demand exceeded output; large current a/c deficit;

mirrored in large surpluses in China and elsewhere.

G F C


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G o a F nanc a Cr s sCapital Flows to Emerging Market

Economies

Very large capital flows to EMEs now outflows in 2009 - largevolatility - implications for monetary management and financial stability


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o a nanc a r s sWorsening Global Economic

OutlookGrowth Forecast of IMF (per cent)

Region April2008

July 2008 October2008

April 2009

20082009 200

8

2009 20

08

2009 2008 2009

Advancedcountries

1.3 1.3 1.7 1.4 1.5 0.5 0.9 (-)3.8

EMEs 6.7 6.6 6.9 6.7 6.9 6.1 6.1 1.6World 3.7 3.8 4.1 3.9 3.9 3.0 3.2 (-)1.3

Global Trade Volume (Goods and Services)World 3.7 3.8 4.1 3.9 3.9 3.0 3.3 -11.0


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ResearchResearch

Index of Crises=Fn(M2 Multiplier, Domestic Credit/GDP,Index of Crises=Fn(M2 Multiplier, Domestic Credit/GDP,Real Interest rate, lending/deposit rate ratio, Excess M1Real Interest rate, lending/deposit rate ratio, Excess M1Balances,M2/Reserves,Bank Deposits, Real ExchangeBalances,M2/Reserves,Bank Deposits, Real Exchangerate, Short term debt/reserves( trade credit and NRIrate, Short term debt/reserves( trade credit and NRI

deposits in banks with exchange guarantees), Currentdeposits in banks with exchange guarantees), Currentac deficit/reserves, Fiscal Deficit/GDP, Governmentac deficit/reserves, Fiscal Deficit/GDP, Governmentdebt/GDP, stock returns, terms of trade, Budgetdebt/GDP, stock returns, terms of trade, Budgetdeficit/GDP, short term flows/GDP, index of financialdeficit/GDP, short term flows/GDP, index of financialliberalization among othersliberalization among others

Time series data of Country and Logit AnalysisTime series data of Country and Logit Analysis


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Identification of Crisis (reserve loss and appreciationof foreign currency) and its Determinants in India

I created an index of crisis( like in Edwards,2004) based on weighted average ofexchange rate( both rupees to US $ and rupees to basket of currencies and sdr ) andreserves rate of change where in the weights are the standard deviation of rate ofchange of exchange rate and reserves. The data came from the Handbook of Statistics,RBI. Years considered were 1971-72 through 2008-09.

If the index in any year was greater than equal to mean of the index +one standarddeviation we called it the crisis year and gave a value one and o otherwise. Using our

first index (weighted average of reserve rate of change and us rupee exchange rate)we found 07 years where we had crisis out of 38 years. These are 1981-82,84-85,88-89,89-90,91-92,92-93,2008-09.

Using my second crisis index (weighted average of reserve rate of change andappreciation of basket of currencies and SDR) i found that in 10 years we had crisissince 1971-72. These are 72-73,86-87,87-88,88-89,89-90,91-92,92-93,95-96,99-00,2008-09.

I further regressed the two crisis indices on its determinants using time series datanamely short term debt/ reserves, trade balance, FDI flows, SBI Advance lending rates,

loans and advances, total financial assistance,M3 Growth, deposit rates, call rates,current account deficit/ GDP,a among others. Logit regression was used for the work.Coefficients to be interpreted in terms of probability. Marginal effects on probability areworked out by multiplying the coefficients with value of PDF depending on values of allthe explanatory variables.


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indexus indexweighted

mean -0.64009 1.32

median -0.34169 -0.2

max 24.4028 23.3

min -28.2775 -24.

sd 13.32411 12.8

skwe -0.01017 -0.1

kurto 2.651387 2.39

bstatistics 0.193079 0.68

pvalue 0.907974 0.70

38


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1IF CRISIS O OTHTERWISE Dependent Variable: SER01

Method: ML - Binary Logit

Date: 12/22/09 Time: 17:16

Sample: 1 38

Included observations: 38

Convergence achieved after 12 iterations

Covariance matrix computed using second derivatives

Variable Coefficient Std. Error z-Statistic Prob.

C -17.472 8.909341 -1.96108 0.0499

SHORT TERM DEBT/RESERVES SER03 0.025521 0.013535 1.885587 0.0594

FDI FLOWS SER05 0.000135 6.71E-05 2.013808 0.044

SBIADVANCE RATE SER15 0.888661 0.519142 1.711788 0.0869

Mean dependent var 0.184211 S.D. dependent var 0.392859

S.E. of regression 0.318481 Akaike info criterion 0.757899

Sum squared resid 3.448636 Schwarz criterion 0.930277

Log likelihood -10.4001 Hannan-Quinn criter. 0.81923

Restr. log likelihood -18.1533 Avg. log likelihood -0.27369

LR statistic (3 df) 15.50643 McFadden R-squared 0.427097

Probability(LR stat) 0.001431

Obs with Dep=0 31 Total obs 38

Obs with Dep=1 7


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Dependent Variable: SER02

Method: ML - Binary Logit

Date: 12/22/09 Time: 17:25

Sample: 1 38

Included observations: 38

Convergence achieved after 10 iterations

Covariance matrix computed using second derivatives

Variable Coefficient Std. Error z-Statistic Prob.

C -3.545018 1.083501 -3.271819 0.

RTTERMDEBT/RESE SER03 0.032139 0.013958 2.302595 0.

SANDADVANCES SER14 7.96E-05 4.53E-05 1.759255 0.

EBALANCE SER13 -1.48E-05 1.63E-05 -0.912317 0.

Mean dependent var 0.263158 S.D. dependent var 0.44

S.E. of regression 0.373049 Akaike info criterion 1.04

Sum squared resid 4.73163 Schwarz criterion 1.21

Log likelihood -15.86643 Hannan-Quinn criter. 1.10

Restr. log likelihood -21.9007 Avg. log likelihood -0.4

LR statistic (3 df) 12.06854 McFadden R-squared 0.27

Probability(LR stat) 0.007152

Obs with Dep=0 28 Total obs

Obs with Dep=1 10


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Conclusion of RegressionConclusion of Regression

ExerciseExercise

High Short termHigh Short termdebt/reserves( generally greater thandebt/reserves( generally greater than25%), net capital inflows more of the25%), net capital inflows more of the

nature of portfolio investment) ,low andnature of portfolio investment) ,low andexcess liquidity in the system throughexcess liquidity in the system throughvarious channels( monetary policy, loansvarious channels( monetary policy, loansand advances and financial assistance,and advances and financial assistance,

Lending rates) can create vulnerabilitiesLending rates) can create vulnerabilitiesin the system and financial crisis.in the system and financial crisis.


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Impulse Response

-4

-2

0

2

4

6

8

10

12

1 2 3 4 5 6 7 8 9 10

SER10SER02

SER03SER04

Response of SER10 to One S.D. Innovations

-10

-5

0

5

10

15

20

1 2 3 4 5 6 7 8 9 10

SER10SER02

SER03SER04


-10000

0

10000

20000

30000

1 2 3 4 5 6 7 8 9 10

SER10SER02

SER03SER04


-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

1 2 3 4 5 6 7 8 9 10

SER10SER02

SER03SER04



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-5

0

5

10

15

2 4 6 8 10 12 14 16 18 20

SER10SER02

SER03SER04


-250

-200

-150

-100

-50

0

50

100

2 4 6 8 10 12 14 16 18 20

SER10SER02

SER03SER04


-400000

-200000

0

200000

400000

600000

800000

2 4 6 8 10 12 14 16 18 20

SER10SER02

SER03SER04


-50

-40

-30

-20

-10

0

10

20

2 4 6 8 10 12 14 16 18 20

SER10SER02

SER03SER04



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Variance Decomposition of Crisis Index(ser10) (see14 period onwards)Ser02(short term debt/reserves), ser03(FDI inflows)

and ser04(SBI lending rate) Variance Decomposition of SER10: Period S.E. SER10 SER02 SER03 SER04

1 10.89255 100.0000 0.000000 0.000000 0.000000 2 11.47911 90.85825 0.491326 5.816073 2.834348 3 11.95784 85.94474 2.429590 7.010690 4.614977 4 12.36843 80.87034 4.882181 7.274282 6.973199 5 12.62156 79.11475 6.203067 7.098214 7.583974

6 12.76926 77.45298 7.458554 7.265468 7.823001 7 12.90372 75.89369 8.422976 7.115942 8.567390 8 13.00137 74.77232 9.057181 7.276772 8.893722 9 13.05441 74.16621 9.424705 7.362394 9.046691 10 13.10872 73.63288 9.663538 7.579985 9.123595 11 13.15754 73.13279 9.813163 7.864468 9.189580 12 13.22732 72.42589 9.881788 8.538001 9.154322 13 13.33020 71.45207 9.889375 9.607735 9.050818 14 13.51499 69.77280 9.811177 11.58476 8.831257

15 13.84006 66.94216 9.610974 15.00459 8.442274

16 14.43643 62.23530 9.209942 20.77965 7.775104 17 15.49713 55.18069 8.560183 29.49489 6.764233 18 17.34114 45.84385 7.662793 41.07157 5.421786 19 20.39794 35.56333 6.649899 53.84511 3.941668 20 25.23001 26.28188 5.718558 65.39688 2.602685


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Granger Causality TestsSBI lending rate have two way causality with crisis index while

short term debt/reserves causes crisis Pairwise Granger Causality Tests Date: 12/27/09 Time: 14:00 Sample: 1 38 Lags: 2 Null Hypothesis: Obs F-StatisticProbability SER02 does not Granger Cause SER10 36 2.60406 0.09008 SER10 does not Granger Cause SER02 0.50195 0.61018 SER03 does not Granger Cause SER10 36 1.24463 0.30205 SER10 does not Granger Cause SER03 0.63031 0.53911 SER04 does not Granger Cause SER10 36 3.57110 0.04021 SER10 does not Granger Cause SER04 3.30854 0.04985 SER03 does not Granger Cause SER02 36 0.17217 0.84263 SER02 does not Granger Cause SER03 0.00379 0.99622

SER04 does not Granger Cause SER02 36 1.10885 0.34267 SER02 does not Granger Cause SER04 1.59652 0.21881 SER04 does not Granger Cause SER03 36 0.56976 0.57147 SER03 does not Granger Cause SER04 2.29824 0.11730


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Conclusions

Innovation accounting shows that short term debt/reserves and Capitalinflows do have impact on crisis index dynamically in future timeperiods (after 14time period inflows of capital have significantexplanation to crisis index ). SBI lending rate have two way causalitywith crisis index while short term debt/reserves causes crisis.

Limitation: Does Financial Liberalization precede a financial crisis.Limitation: Does Financial Liberalization precede a financial crisis.Looking for an financial liberalization index( over the years) which canLooking for an financial liberalization index( over the years) which cancapture: interest rate deregulations, removal of entry barriers,capture: interest rate deregulations, removal of entry barriers,reduction in reserve requirements, easing of credit control,reduction in reserve requirements, easing of credit control,implementation of prudential rules, stock market reform, privatizationimplementation of prudential rules, stock market reform, privatizationof state owned banks, external liberalization,M2Multiplier,depositof state owned banks, external liberalization,M2Multiplier,depositlending ratio, real interest rate, private sector credit/GDP).lending ratio, real interest rate, private sector credit/GDP).

More Involved econometric work should have an index of bankingMore Involved econometric work should have an index of banking

regulation, stock returns as well as an index of financial liberalization asregulation, stock returns as well as an index of financial liberalization asright hand side variables as potential determinants of crisis.right hand side variables as potential determinants of crisis.

R f i I t ti l Fi i lReforms in International Financial


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Reforms in International FinancialReforms in International Financial

Architecture (official mechanismsArchitecture (official mechanisms

which facilitate financial stability) towhich facilitate financial stability) to

Reduce Vulnerabilities of CountriesReduce Vulnerabilities of Countries Transparency in reporting of Macroeconomic and Microeconomic Indicators, not merelyTransparency in reporting of Macroeconomic and Microeconomic Indicators, not merely

information but methodology as wellinformation but methodology as well

Strengthening of Financial Institutions including Banks : BIS Basel II Norms on CapitalStrengthening of Financial Institutions including Banks : BIS Basel II Norms on CapitalAdequacy and Internal Risk Assessments through Value At Risk Models( Market Risk butAdequacy and Internal Risk Assessments through Value At Risk Models( Market Risk butlimitations). Curb other risks like Operational Risk, Credit Risk regulations( capital assetlimitations). Curb other risks like Operational Risk, Credit Risk regulations( capital assetratios, credit expansion, maturity mismatches) in boom and recessionary conditions, Moreratios, credit expansion, maturity mismatches) in boom and recessionary conditions, MoreIMF Money like SDRs and liberal disbursement policy, Global Supervisory StandardsIMF Money like SDRs and liberal disbursement policy, Global Supervisory Standards

required,G-20(FINANCIAL STABILITY BOARD to Unite Regulators and IMF in providing earlyrequired,G-20(FINANCIAL STABILITY BOARD to Unite Regulators and IMF in providing earlywarnings of potential threatwarnings of potential threat

Nationalization vs Private Sector Bail In at the time of Crisis. Bailouts do not make senseNationalization vs Private Sector Bail In at the time of Crisis. Bailouts do not make sensewhen there are excessive involved. Measured risks promotes stability and long runwhen there are excessive involved. Measured risks promotes stability and long rungrowth( Rao,2009)growth( Rao,2009)

Adequate Supervision and prudential Regulations to Curb Distortions Created byAdequate Supervision and prudential Regulations to Curb Distortions Created byAsymmetric InformationAsymmetric Information

Coordination of Fiscal Policies and Monetary Policies across Countries to Curb ExcessiveCoordination of Fiscal Policies and Monetary Policies across Countries to Curb ExcessiveSurplus and Deficits in the Balance of PaymentsSurplus and Deficits in the Balance of Payments

Invest the Surplus (foreign exchange in Infrastructure, Social Sector), Questions to beInvest the Surplus (foreign exchange in Infrastructure, Social Sector), Questions to beanswered is What are Adequate Level of Reserves( ft of volatility in export receipts, GDP,answered is What are Adequate Level of Reserves( ft of volatility in export receipts, GDP,population, REER volatility, imports); three months of reserves are adequate andpopulation, REER volatility, imports); three months of reserves are adequate andinstruments of financial intermediaries (SPVs)? Cost of maintaining reserves( sterlizationinstruments of financial intermediaries (SPVs)? Cost of maintaining reserves( sterlizationand investment in low interest liquid debts )and investment in low interest liquid debts )


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Reforms

Growth of Manufacturing Sector so that excessive money does notGrowth of Manufacturing Sector so that excessive money does notchase too few goodschase too few goods

Total Factor Productivity growth instead of Factor accumulation( leadingTotal Factor Productivity growth instead of Factor accumulation( leadingto diminishing marginal productivity)to diminishing marginal productivity)

Controls on Movement of Financial Capital and keeping currencyControls on Movement of Financial Capital and keeping currency

competitive so that adequate reserves can be build up, REDUCINGcompetitive so that adequate reserves can be build up, REDUCINGSHORT TERM DEBT AND VOLATILITY IN CAPITAL INFLOWS,SHORT TERM DEBT AND VOLATILITY IN CAPITAL INFLOWS,STERLIZATION IS IMPORTANTSTERLIZATION IS IMPORTANT

Coordinated approach of regulation moving away from pillarsCoordinated approach of regulation moving away from pillarsapproach(Mathur,2001). Take care of regulatory arbitrage.approach(Mathur,2001). Take care of regulatory arbitrage.

Capital provisioning and regulation of shadow bankingCapital provisioning and regulation of shadow banking

Tax at good times and spend it at bad times (R Rajan)Tax at good times and spend it at bad times (R Rajan)

Boring Banking (Krugman)Boring Banking (Krugman)


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Indias Approach to ManagingFinancial Stability

Financial sector, especially banks, subject to prudential regulation

both liquidity and capital. prudential limits on banks inter-bank liabilities in relation to their net

worth;

asset-liability management guidelines take cognizance of both on and offbalance sheet items

Basel II framework: guidelines issued. Dynamic provisioning NBFCs: regulation and supervision tightened - to reduce regulatory

arbitrage.

NPA (reduced from 15% of loans disbursed in 1997 to less than 5% today),short term debt/ Reserves 19%,cad/gdp 2.6 IN 2008,FISCAL DEFICIT/GDP6.14, Most of the external debt is long term debt for India, debt/GDPbelow 60%(Masstricht Criteria).

CAMELS APPROACH TO BANKING( CAPITAL ADEQUACY, ASSET QUALITY,MANAGEMENT,EARNINGS,LIQUIDITY AND SYSTEMS ANDCONTOLS);BANKING REFORMS(PRUDENTIAL REFORMS AND STANDARDS,SUPERVISION, LEGAL FRAMEWORK)


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