Financial stability key issue: Reddy

Maintaining stability in the financial system is the main challenge for the Reserve Bank of India (RBI), according to Y V Reddy, the governor.

"We have been moving from a government-dominated financial system to a market-oriented one. The government's domination was, in a sense, imparting too much stability through rigidity and too little efficiency. Enhancing efficiency and at the same time avoiding instability in the system has been the challenge for the RBI," Reddy said in his speech at the Bank for International Settlements (BIS) in Basel on June 27.

He stressed the importance of putting in place special defences to ensure financial stability with the prospect of volatile capital flows.

Stating that the volatility in capital flows can cause instability, Reddy said, "Many emerging market economies do not seem to have adequate self-correcting mechanisms in respect of such cross-border capital flows.

"The issues relating to cross-border supervision of financial intermediaries in the context of greater capital flows are just emerging and these need to be addressed."

Last week, at a central bank governors meeting in London, Reddy said India would have to proceed with caution in freeing up its capital account, given its 'potential for shocks'.

The concept of financial stability in the Indian context, according to him, is ensuring uninterrupted financial transactions, maintenance of a level of confidence in the financial system, and absence of excess volatility that unduly and adversely affects real economic activity.