RBI favours placing limit on leveraging by unregulated entities

The Reserve Bank of India (RBI) has favoured a quantitative limit on leveraging by unregulated financial sector players to raise funds from the capital market in order to contain any adverse effect on the system.

Elaborating on regulatory framework to capture links between regulated entities and those outside its ambit, RBI Deputy Governor Shyamala Gopinath said rules should be able to pinpoint the nature of links between entities that might be considered inducing vulnerabilities in the system.

She was speaking at seminar on “Emerging from Crisis…” in Washington DC organised by the US Federal Reserve on June 3-5.

Some systemically significant entities, though, may still need a formal prudential regulatory structure, including capital adequacy requirement, she said.

The main task will be to identify entities from the haze of the unregulated cluster, that have either have significant direct links with the regulated clusters or exist side-by-side any market segment where regulated entities are active, she said.

The framework should have a reporting system to capture the interconnected flows within the identified sub-system – the regulated clusters and the unregulated entities on a regular basis.

In India’s case, regulation proved to be an effective combination since banks’ exposure to such entities could be regulated through absolute exposure norms or even tweaking the risk weights applicable to such exposures.

The problem would be much more involved in predominantly market based financial systems where direct bank linkages are not very obvious. But even in such regimes the indirect linkages of banks were enmeshed in the maze. Hence, it is important to ensure that the markets too do not provide leverage capabilities to such entities beyond a limit, she added.