Regulate right says RBI’s Rajan

Saturday, 26 July 2014 00:00 - - {{hitsCtrl.values.hits}}

Financial sector should be cautious in placing all its faith in capital regulation says India’s Central Bank Chief
Says best to have uniform regulation across the system rather than pushing from one side
Points out overemphasising of capital regulation is a concern
Says emerging countries must ask themselves if relevant to follow capital regulation agenda of industrialised countries

By Shabiya Ali Ahlam With capital regulation having captured the interest of many in recent years following the financial crisis, the Indian Central Bank Chief advised the sector to be cautious about placing all its faith in that area alone as it could be offering low risk to the wrong asset type. “There are few reasons as to why capital regulation becomes problematic. In some instances it tends to provide greater risk for the lowest capital. We have to be cautious in putting all our faith in this alone. One of the worries with capital requirement is that it may coordinate with risk weighted assets that may not be appropriate and result in the creation of a systemic risk that the regulator is trying to avoid,” said Reserve Bank of India (RBI) Governor Dr. Raguram G. Rajan on Thursday (24). He was delivering a briefing to a high-profile gathering at the Central Bank of Sri Lanka (CBSL) on the topic ‘Capital Regulation:

How Much is Too Much?’. Dr. Rajan made these view shortly after the RBI entered into a landmark bilateral agreement with the local monetary watchdog allowing it to access the Sri Lankan Government securities market up to a maximum value equivalent of $ 500 million. In exchange the CBSL will be able to further diversify its reserves management activities into Indian rupee-denominated assets. Assuming the piling of capital regulation on banks work, Dr. Rajan pointed out those risks that do not go through the banks will find its way to the unregulated areas of the financial system. “While there is much regulation for the regular financial system, there is a large part of the shadow financial system goes unregulated. The more you push on the regulatory part of the banks, the more risk will go to the shadow parts of the financial system. It is best to have uniform regulation across the system rather than pushing it from one side and seeing the risk migrate to the other,” he told a fully-packed audience that consisted of visiting Governors of South Asian Association for Regional Cooperation (SAARC) countries, leaders from the local financial sector, economists and CB officials. Observing that one of the concerns of capital regulation is that it is often over-emphasised, Dr. Rajan stressed that over and above governance and incentives the regulators need to offer the right incentives and take the right action at the right time. “If the regulator lags in good times and become excessive during bad times we will have problems. By focusing excessively on capital regulation we may underemphasise other areas that that comes under the BASEL which are equally important,” he pointed out. Rajan also attempted to draw attention to the fact that while the banks and financial systems of emerging economies are not similar to that of industrialised countries, which have larger and complex activities, emerging regions should ask themselves if they are held down by a regulatory path of countries that has similar financial needs. “I am not asserting this but it is a think we must explore the thought because in many of these situations we take the agenda laid out by these (industrialised) countries that is being driven by the thought of the great financial crisis which hit them much more than us (emerging countries),” he said. Throughout the presentation Rajan maintained and emphasised that capital regulation is vital to discipline the banking and financial sector and assists in loss absorption.