Financial Regulation More Complex Than Other Sectors, Says RBI Governor
Reserve Bank of India Governor Sanjay Malhotra has stated that financial regulation carries far greater complexity and consequence than regulatory frameworks in most other sectors, as it protects individual customers while safeguarding systemic stability.
Key Takeaways
- Financial regulation protects both consumers and systemic stability
- Bank failures create cascading effects across the economy
- Financial stability remains RBI’s “north star” for policy
- Short-term growth at stability’s cost causes long-term damage
Interconnected System Vulnerable to Shocks
Speaking at the Second V.K.R.V. Rao Memorial Lecture at Delhi School of Economics, Governor Malhotra highlighted that financial institutions are interconnected in ways non-financial entities rarely are, making the system highly sensitive to shocks.
“Financial regulation is more complex and more consequential than regulation in other sectors. It is not merely about protecting individual consumers and promoting efficiency – though these are of paramount importance – but also about safeguarding systemic stability.”
He explained that when a bank fails, it creates a cascading effect where depositors lose savings, inter-bank markets freeze, credit supply contracts, and payment systems falter. Such disruptions flow into the broader economy and may trigger systemic crises, as demonstrated by the 2008 global financial crisis.
Inherent Fragility of Banking System
The RBI Governor detailed how banks operate on maturity and liquidity transformation, accepting short-term deposits while extending long-term loans. While economically valuable, this creates vulnerabilities that escalate rapidly during uncertainty.
“A loss of confidence can trigger bank runs, converting liquidity problems into solvency crises within days,” he said.
Unlike manufacturing units that can temporarily shut down, banks facing runs must be resolved immediately to prevent contagion.
Procyclical Nature of Financial Markets
Malhotra highlighted the procyclical and herd-driven nature of financial markets. During booms, risks are under-priced, lending standards weaken, and asset bubbles emerge. Conversely, during downturns, credit recedes when most needed, amplifying business cycles and making financial markets more volatile than other sectors.
Financial Stability as the North Star
The Governor emphasized that for the Reserve Bank, financial stability remains the “north star.” He cautioned that short-term growth achieved at stability’s cost leads to deeper long-term damage, as financial instability can offset gains from high short-term growth and make economic recovery slower and more distressing.
He defined financial stability as a condition where the financial system – comprising intermediaries, markets, and infrastructure – can withstand shocks and unravel financial imbalances, reducing disruptions that impair savings allocation to profitable investments.
