Financial regulation more complex than other sectors as it safeguards systemic stability: RBI Governor

NEW DELHI: Financial regulation carries far greater complexity and consequence than regulatory frameworks in most other sectors, as it not only protects individual customers but also safeguards systemic stability, stated Reserve Bank of India (RBI) Governor Sanjay Malhotra.

Delivering the Second V.K.R.V. Rao Memorial Lecture at the Delhi School of Economics in New Delhi on Thursday, the Governor highlighted that financial regulation plays a critical role in maintaining the health of the overall economy.

He stated, “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.”

Malhotra said financial institutions are interconnected in ways non-financial entities rarely are, making the financial system highly sensitive to shocks.

“If a bank fails, it has a cascading effect – depositors lose savings, inter-bank markets freeze, credit supply contracts and payment systems falter,” he said.

Such disruptions, he added, flow into the broader economy and may eventually trigger a systemic crisis. He pointed out that the 2008 global financial crisis in the Advanced Economies (AEs) demonstrated this with devastating clarity.

The RBI Governor further explained that the inherent fragility of financial institutions adds to the regulatory challenges. Banks operate on maturity and liquidity transformation, accepting short-term deposits and extending long-term loans.

While this function is economically valuable, it creates vulnerabilities that can rapidly escalate during periods of uncertainty.

“A loss of confidence can trigger bank runs, converting liquidity problems into solvency crises within days,” he said.

Unlike a manufacturing unit that can be shut down temporarily, a bank facing a run must be resolved immediately to prevent contagion.

Malhotra also highlighted the procyclical and herd-driven nature of financial markets. During boom periods, risks are under-priced, lending standards weaken and asset bubbles emerge. Conversely, during downturns, credit recedes precisely when it is most required. This amplification of business cycles, he said, makes financial markets distinctly more volatile compared to most other sectors.

He emphasised that for the Reserve Bank, financial stability remains the “north star”. Short-term growth achieved at the cost of stability, he cautioned, can lead to deeper long-term damage.

He said financial instability can not only offset gains from high short-term growth but also make economic recovery slower and more distressing.

Defining financial stability, the Governor said it is a condition in which the financial system, comprising financial intermediaries, markets and market infrastructure, is capable of withstanding shocks and the unravelling of financial imbalances, thereby reducing the probability of disruptions that significantly impair the allocation of savings to profitable investment opportunities. (ANI)