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Part II. Annual Statement on Developmental and Regulatory Policies for the Year 2007-08


110.The stance of the Annual Statement on Developmental and Regulatory Policies for the year 2006-07 for strengthening the financial system, with an emphasis on the quality of financial assets and state of financial market conditions, was reinforced in the Mid-Term Review of October 2006. The main endeavour has been to put in place appropriate risk management and counter-cyclical prudential measures while promoting the integration of various segments of the financial markets and enhancing the flexibility of market constituents in their operations. Along with the ongoing liberalisation of foreign exchange transactions, several measures were taken towards developing an appropriate environment for extending financial services to all segments of the population. The Third Quarter Review of January 2007 observed that in the global financial markets there are indications of risks becoming more diversified and, therefore, there is an increasing discomfort of the possibility of tail risk materialising. Accordingly, it reinforced the emphasis on macroeconomic and financial stability with a view to managing the challenges of sustaining a higher growth path and the attendant pressures on the financial system in terms of expanding financial intermediation, improving allocational efficiency and augmenting the mobilisation of resources to finance the gathering pace of growth. Expressing renewed concerns about the rapid expansion of bank credit for three years in succession and the surge in capital inflows, the Third Quarter Review called for concerted actions in fiscal, external, monetary and prudential policies. Provisioning requirements on standard assets were enhanced and risk weights were increased with regard to exposure to sectors such as real estate, capital markets, consumer loans and systemically important non-banking financial companies with a renewed emphasis on credit quality. Furthermore, the ceiling on administered interest rates relating to Non-Resident Indian (NRI) deposits was reduced with a view to fortifying liquidity management and ensuring orderly conditions in the financial markets.

111.It has been the endeavour of the Reserve Bank to develop a robust, efficient and diversified financial system so as to anchor financial stability and to facilitate effective transmission of monetary policy. Simultaneously, the emphasis has been to evolve an effective and comprehensive regulatory regime that is alert to any possible build-up of financial imbalances and which demonstrates a preparedness to respond proactively with policy responses. The focus has been on providing flexibility to the financial system contextually with a view to deriving optimum benefits. There has been a concerted and calibrated move to rebalance the regulatory and supervisory role and customer awareness so as to ensure an inclusive and equitable financial system. In this context, the Reserve Bank has adopted a broad-based, participative and consultative approach in the conduct of its developmental and regulatory policies with the involvement of all stakeholders in the processes leading up to policy formulation. The importance of communication has received significant emphasis in the recent period and the Reserve Bank has been reaching out in order to encompass the widest sections of society in the financial system through the spread of financial education so as to encourage a more informed evaluation of its policies.

112.Against this backdrop and in the light of the current macroeconomic environment and external developments as discussed in Part I of the Statement, the Annual Statement on Developmental and Regulatory Policies focuses on certain key areas. First, the maturing of the financial sector will continue to warrant the use of prudential tools in support of monetary policy. Second, the process of liberalising foreign exchange transactions would be carried forward with some acceleration in the pace of capital account liberalisation. Third, it is proposed to further consolidate the development of various segments of the financial markets with proper checks and balances in order to enhance allocative efficiency. Fourth, in the context of the volatility and risks in financial markets arising from cross-border flows, it is proposed to draw up a road map for introduction of currency and interest rate futures. Fifth, preparing the banks to migrate to Basel II norms with specific and limited dispensation to those sectors which do not pose systemic risks, consolidating the banking sector including co-operatives and regional rural banks (RRBs) and implementing prudential measures in line with international best practices in the financial sector, assume priority for improving operational efficiency and public confidence. Sixth, in order to address the developmental needs of agriculture and small and medium enterprises (SMEs), there is a need to prioritise and incentivise credit delivery.

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