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Stability in the changing environment

Recent developments in India and outside have redefined financial stability to mean more than just the avoidance of crises and posed new challenges to the central banks in framing macro-economic policies. Nowadays, it is seen as a condition in which the financial sector carries out the intermediation function between savers and investors smoothly and efficiently while simultaneously managing the various risks. Across the globe in the recent past, financial crises have led to macro-economic instability and inflicted severe costs all round. In several countries including India, the financial sector has grown at a faster pace than the real economy. As the financial system matures, the share of non-monetary assets goes up. Also, new exotic instruments such as derivatives become popular, and traditional monetary policies and financial sector supervision become less effective. Integration of domestic markets with one another and with the global markets calls for greater coordination among the regulators both at the national and international levels.

In India, issues connected with financial stability moved to the centre stage during the mid-1990s when the impact of the first wave of financial sector reforms began to be felt. In the pre-reform era, it was the predominance of government ownership that gave stability to the financial sector, which however has to contend with a highly rigid and sheltered environment. The two defining characteristics of economic reform have been the diluting of government ownership and control and the adaptation of the leading institutions to the market forces, notably, competition. With stability as its central plank, financial sector reform in India has encompassed a number of policy measures aimed at strengthening the institutions and improving their efficiency. The vicissitudes of the global markets have been increasingly felt in India too. Large capital inflows that continue to pour in despite the gradualist stance — there has been no hurried implementation of capital account convertibility — have impinged on the stability of both the stock markets and exchange markets. The health of the financial sector has become critical not only for effectively transmitting signals but also for ensuring a foolproof payments system. Another major development has been the emergence of financial conglomerates with their own systemic implications. More recently, there has been a concerted drive to impart transparency in the working of the financial sector with a view to enhancing market discipline. As the Reserve Bank of India puts it, the stability of the financial system is enhanced when institutions and markets function on the basis of informed decisions.

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