The Indian financial system in general and banks in particular have acquitted themselves creditably in the face of the serious global crisis. The reasons why the domestic financial institutions have remained robust and resilient when many of the world’s top banks and institutions collapsed and had to be rescued with public money are fairly well known by now. The Reserve Bank of India‘s report on trend and progress of banking for 2008-09 provides an incisive analysis of the developments that made last year a valuable learning period for the banks and regulators everywhere. The exposure of Indian banks to the toxic assets was minimal. More importantly, the RBI’s counter-cyclical prudential measures, during both the credit boom and the downturn, have played a significant role in minimising the deleterious consequences of the crisis. The second point, not fully appreciated initially, has since been given its due in policy discussions even at the global level. The initiatives taken by the RBI were mainly aimed at strengthening the banking system and financial markets while ensuring uninterrupted flow of credit to different sectors of the economy. The monetary policy shifted its focus from monetary tightening during the first half of 2008-09 to “aggressive easing” in the second half, using both conventional and unconventional tools.

If Indian banks and their regulators can take credit for coping well with the crisis, the outlook for the global banking sector remains weak on both sides of the Atlantic over the medium- and long-term, despite the critical rescue programmes. Although the financial regulatory system in the U.S. was shown up as a major lacuna during the crisis, no comprehensive overhaul has taken place. As the global economy improves by next year, the level of complacency might increase. There is an urgent need for achieving a greater degree of coordination in regulatory policies across the world. Almost all the factors that were behind the crisis have global implications. For instance, financial innovation and integration have increased the speed and extent to which shocks are transmitted across asset classes and countries, blurring the distinction between banks and other institutions. The nascent stage of development of the credit derivatives market in India and the perseverance of prudential policy that discourages excessive risk taking are some of the factors that helped banks and markets insulate themselves. Obviously, these policies will have to be reviewed in order to reinforce financial stability, financial sector governance, and risk management practices.

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