Safeguarding Financial Stability in an Era of Financial Fragility:An Indian Perspective

The recent global crisis has brought several issues to the forefront of macro-policy analysis including most prominently (i) pro-cyclicality of bank capital regulation (ii) role of asset bubbles (iii) high social costs of financial failures and (iv) high leverage of financial institutions. It has been realised by the global community that tackling these problems calls for a globally coordinated approach in which both national regulators and multilateral global institutions/agencies will have to play a vital role. The focus of this paper is on the role of national regulatory and supervisory authorities, with special emphasis on seven key policy areas, viz., (i) making monetary policy respond to asset prices (ii) strengthening and expanding the scope of regulation and supervision (iii) controlling leverage of financial institutions (iv) dampening pro-cyclicality of capital requirements (v) reducing costs of financial failures (vi) devising market incentives for prudent behaviour and (vii) a shift from micro-prudential to macro-prudential regulation. We examine to what extent the official financial supervisory and regulatory authorities in India have fulfilled this role successfully. In the latter part of the paper, some attention is also devoted to the role of global multilateral institutions in ensuring financial stability.