Dr YV Reddy special- S. Guhan Memorial Lecture

Dr Subbarao in his recent speech provided refernce to a recent speech Dr Reddy gave in memory of S. Guhan.

I just searched and found the text of the speech here. He sets the agenda for the financial system right:

Currently, there are several responses to this question of what next for India’s financial sector? I will state a few of them and briefly comment on each of them.

First, some say that India has been saved from the financial crisis only because the policy was conservative and did not act to improve the efficiency of the system. Hence, the prescription is to act now.

This view is not right simply because India was active in policy interventions in both monetary and financial sector. RBI adopted active countercyclical policy; while many others failed to intervene. There is another problem with acting rapidly or comprehensively now for reform; because there is no agreement on right model for financial sector.

This is precisely the point. It is not really policy conservatism  but early activism actually.

He then says it is wrong to sit idle and do no reform but let us not overdo action as well

Second, some say that we have had good growth, stability and have withstood crisis. Hence, let us proceed with what we already have in place.

In my view, inaction across the board is wrong since there are several inadequacies in our financial system, ranging from credit-culture to financial exclusion and poor service. Serious infirmities that could cause a crisis may not exist in our system but financial sector is yet to fully serve the needs of real sector. The needs of the real sector can be met only when there are synchronised reforms in both real and financial sector.

He uses housing finance as a example to compare reforms in real and finance sector.

A thoughtful and pragmatic approach to segment or sector specific inter connected issues of real and financial sectors in India is needed; and not inaction.

This point may be illustrated with housing finance. Housing should be a priority for India, in view of demographics, growth trend and urbanisation. Hence housing finance ought to be encouraged. But for housing finance to be viable and efficient, there should be reasonably good housing markets, preferably liquid markets.

The nature of formal and informal construction activity as well as financing models; high transaction costs in terms of registration fee etc; difficult tenancy laws; non-standardised layouts etc; inadequate processes of price discovery; unrealistic loan to rental value ratios etc., make the housing markets in general, very complex and illiquid at this juncture. Thus, developments and reform in housing products and housing finance products should be reviewed together while focusing on increasing of housing finance and innovating related products.

Let me not say anything on housing markets. I have already spilled enough venom on the sveral issues. It is such a terrible set of market practices…

He then points the lessons from the crisis are not out of the box but fundamental. Things like Tobin tax, capital controls have been there since ages but were not taken seriously.

He then looks at 9 questions:

  • First Question: Is macro economic management reasonably balanced?
  • Second Question: Is monetary policy sound and well equipped?
  • Third Question: Are there suitable mechanisms for regulatory coordination in financial sector?
  • Fourth Question: Are there incentive systems that are inappropriate for stability of the financial system and the interests of depositors or investors?
  • Fifth Question: Is there evidence of conflicts of interests in financial sector?
  • Sixth Question: Is there evidence of excessive financialisation?
  • Seventh question: Is there any evidence of irresponsible lending, like the sub prime in U.S.A.?
  • Eighth question: Are there any concerns relating to integrity of financial markets?
  • Ninth and last question: Is the banking system, sound, resilient, efficient and performing the functions expected of the system?

Read the speech for the answers. As usual very informative and food for thought speech. Requires many re-reads to get the points completely.

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