Questions:

1. What causes financial instability?

2. How can RBI deal with financial instability?
3. Trade-off between financial stability and growth?

Reasons for financial instability
Increased non-official capital flows across countries through banks and international capital
markets.
Hasty and non-strategic liberalisation
Deregulation of financial sector
Opening up of the capital account in many countries
Intiatives by RBI
Had set up the Committee on Financial Sector Assessment in 2009
Will setup a dedicated interdisciplinary Financial Stability Unit with the remit to assess the
health of the financial system with a focus on identify and analysing potential risks to
systemic stability and carrying out stress tests on an ongoing basis
Financial Stability Reports are being released
Financial Stability Report
Three FSRs released till June 2011
First was released in March 2010
As per the three FSRs released so far, there is no serious threat to the Indian financial system
FSR 2011
o states that the Indian financial system remains stable in the face of some fragilities
being observed in the global macro-financial environment.
o Banking sector continues to be stable
o Banking stability indicator confirms the overall improvement in the stability of
banking sector
o Toxity index/vulnerability index: the probability of a bank causing distress to
another bank or being affected by the distress of another bank
o
FS in India
The relatively crisis free environment in the Indian financial system can be attributed to the
strength of state home grown policies pursued with caution and prudence.
In the late 1990s, FS was incorporated as a specific objective of the RBIs policy after the
Asian Financial crisis.
Present weaknesses in the financial system
o Greater access of domestic corporate to ECBs has resulted in increased currency
mismatches
o Increased reliance on market borrowings could adversely affect the liquidity position
of banks
o There remains gaps in the regulatory framework for NBFCs
o