The Reserve Bank of India (RBI) on Thursday joined the growing band of central banks that publish periodic assessments of the risks in the financial systems they regulate and the threats these risks pose to the smooth functioning of the wider economy.
The first Financial Stability Report brought out by the Indian central bank has a lot of predictable economic analysis that RBI watchers are already aware of, but it also provides a welcome wealth of data and analysis that are outside the ambit of the usual economic reviews RBI publishes.
Illustration: Jayachandran / Mint
More information will now be available on issues such as off balance sheet exposures of Indian banks, mark-to-market losses, exposures to credit derivatives, the composition of regulatory capital and how banks perform under stress tests.
Importantly, RBI has tried to define financial stability, which cannot be encapsulated in a single number, unlike an inflation target, and hence is often left undefined. It seems RBI will be tracking four sets of parameters in its quest to maintain financial stability: excessive volatility in interest rates, exchange rates and (please note) asset prices; signs of excess leverage in the financial sector, companies and households; systemic buffers in the financial sector such as (we assume) regulatory capital; and the unregulated parts of the financial sector.
An equally important question right now is what will be done with such financial stability reports. The past two years have showed without a doubt that malfunctioning financial systems can threaten the real world of output and jobs. Central banks have been goaded to stop focusing on managing inflation through changes in short-term interest rates and also take up financial stability as an explicit goal. Now that the finance minister has announced his intention to set up an apex Financial Stability Board to oversee macro-prudential regulation, it is to be seen to what extent RBI will be allowed to act on the basis of the analysis it offers in its financial stability reports.
The first such report does leave us with the sense that the Indian financial system is in safe territory right now. The central bank has offered a composite financial stress indicator that is at its lowest level since January 2007—and far lower than the peak of October 2008, when the collapse of investment bank Lehman Brothers in the US had rattled the Indian financial system. It is the Indian central bank’s deft handling of monetary and financial sector policies in the bubble years that ensured that the pain was mild and brief.
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