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Indian Financial System

Notes

Online links www.bis.org
This website provides information about world financial markets and
international debt outstanding.
www.federalreserve.gov
This website provides information about financial markets securities holdings.
www.thebanker.com

This website provides information about the largest banks of the world

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Case Study Should Financial Systems be Rule-based?

A fter evaluating the pitfalls and advantages of both the systems, there is a view
emerging that the financial system should be more rules-based.
The recent global meltdown has proved one thing: Neither a rules-based regulatory system
nor a principles-based regulatory system is a guarantee against bank failure. However,
after evaluating the pitfalls and advantages of both the systems, there is a view emerging
that the financial system should be more rules-based; this is especially true in the UK.
In contrast, two committees set up in India – the Percy Mistry Committee (2007) and the
Raghuram Rajan Committee (2008) – to look into financial sector reforms have
recommended that India's regulatory regime should move from rules-based to a principles-
based one.

Principles-based regulation (PBR) implies moving away, wherever possible, from
dictating, through detailed prescriptive rules and supervisory actions, how firms should
operate their businesses. Rules-based regulation, it is pointed out, is too rigid and
prescriptive, and often the regulator and the regulated adopt adversarial and antagonistic
postures. Some of the countries that follow principles-based regulatory systems are the
UK, Australia, Canada and Ireland. Some of the leading countries whose regulatory regime
is based on rules are the US, Spain and India.
However, as noted in the Turner Review, banks in countries following either of the
systems have failed. For example, banks have failed in the US and the UK. So in a way,
neither of the regulatory systems has proven to be robust. One way to draw lessons from
the crisis would be to examine what countries such as India, Spain and Canada did right to
insulate their financial systems from succumbing to the global crisis.
Spanish Method
It would be worthwhile to examine the approaches of the various regulators to housing or
mortgage finance. Spain, which follows a rules-based system, has a clearly spelt out mortgage
risk policy for its credit institutions. Banco De Espana (BE) lays down that lending policy
of credit institutions for mortgage should take into account the repaying capacity of the
borrowers and should not just be based on the collateral. BE also emphasises on the
importance of the loan to value (LTV) ratio. It cautions its credit institutions against being
too permissive about LTV as this typically increases the expected losses in a mortgage
loan portfolio.
Contd...

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