Trends in International Banking
I am very happy to be with you on this occasion. I would like to commend the Indian Banks' Association for organising the International Banking Conference at a very timely and critical juncture.
The theme of the Conference assumes great significance in the current international environment. In the context of the Asian financial crisis and the continuing turbulence in the international financial markets, the formulation and application of international rules for sound banking practices has become a critical issue. The ongoing efforts in this direction are supported by extensive enquiry into the identification of the causes of banking crises, the conditions under which these crises are likely to occur and early warning systems which can trigger preemptive policy action.
As you know, international financing through bank lending grew at a vigorous pace in 1997 with a sharp increase in banks' involvement in the securities markets. Thus, international syndicated loan facilities reached a record volume of US $ 1.1 trillion and, credit flows intermediated by international banks rose to an all-time high of US $ 1.2 trillion, almost entirely through inter bank business. This picture has changed dramatically in 1998. In the first quarter of the year, there was a decline of US $ 0.4 billion in credit flows as against an expansion of US $ 451 billion in the last quarter of 1997. The decline in bank lending as well as overall private financing has been even sharper in Asia. During the first quarter of the current year, gross private financing from all sources to Asian economies is estimated to be 10 to 15 per cent of the monthly average of the previous year.
The unsettled environment in which international banking has operated in 1998 has underscored the complementarity between macroeconomic stability and financial sector strengthening. Domestic banking systems worldwide are going through a major restructuring. Over the recent years various committees of national experts supported by the BIS have focused increasing attention on the recommendation of international standards and practices for banking sectors to adopt in the context of the globalisation of financial markets. The Asian crisis has provided impetus for bringing forward these initiatives.
It is also interesting to know that with the phenomenal advances in telecommunications and the synthesis of information and computer technology, capital movements have completely dwarfed the cross-border movement of goods and services and have become the new engine of global integration. These developments have fundamentally changed the structure of the banking system, its orientation and its vulnerability to risks.
Until lately, banking systems were domestically oriented. National policy objectives embodied in the mobilisation of domestic saving, the adequate provision of credit with directed lending targeted at specific sectors of the economy, extending the geographical spread of the banking function and raising resources for financing public sector deficits primarily guided the conduct of banking activity. This necessitated specialisation, and segmentation between banks and other financial institutions was clearly defined. Foreign exchange constraints necessitated recourse to exchange control. Managed exchange rate and interest rate regimes also limited the exposure to external crises.
However, in the nineties, banks have become more global in their reach and in the diversification of their portfolios. They operate with greater freedom than before. Furthermore, there is more universal banking today than in the past. Banks' balance sheets have become more vulnerable to external shocks. The cross border diversification of assets and liabilities has thrown up the potential of mismatches. In the globalised financial system, opportunities to maximise profits are accompanied by an explosion in the volume and nature of risks and banks are confronting increasing pressures in this high yield and high risk market environment.
At present there exists a large disparity in the risk management practices pursued by banks across countries. Given the growing integration of financial markets and the danger of contagion spreading from one country or region to other countries, for the regulators, identifying "best practices" reflecting the country specific requirements vis-à-vis the international norms has become necessary. In the management of systemic risk, coordinated international banking supervision is, therefore, gaining importance. Development of credit derivative markets and securitisation of bank assets are areas which increasingly absorb regulators' attention and involvement. Sound accounting and transparent financial disclosure constitute the key to the health of the banking system in a globalised market. As financial innovations render traditional techniques for assessing capital adequacy less appropriate, banks' internal risk measurement systems could provide valuable information for prudential oversight.
The process of achieving global convergence towards international rules for the banking sector has been provided strong momentum by the initiatives undertaken in the BIS under the Basle process, the Willard Working parties, the Institute of International Finance and the Federal Reserve System Task Force on Internal Credit Models. Efforts are underway to reach a broad consensus on the recommendations of these groups. In this process, emphasis has been placed on securing the participation of national experts from a large number of countries.
The multilateral accord on financial services which came into being under the aegis of the World Trade Organisation in December 1997 also has significant ramifications for the alignment of domestic banking systems into the global order. Over 65 WTO members have made commitments in banking services involving an estimated US $ 38 trillion in global bank lending. As this process of closer external linkages gathers momentum and competition intensifies, domestic banking systems could expect to face increased competition with an emphasis on improving customer services, reduction of costs and strengthening of prudential norms, better risk management, higher level of professional expertise, technological upgradation and overall efficiency.
Banking Sector Reforms in India
It is against the above background that we have to consider the urgent need to accelerate the process of financial reform in India. Initially, in India, banking sector reforms were undertaken as part of a comprehensive package of structural reforms. They took the form of modifications in the policy framework to improve the operational efficiency of the banking system, strengthening of the financial health of banks, building the infrastructure in terms of supervision, audit and technology and upgrading the level of managerial competence.
Significant progress has been made in the first phase of reforms introduced since 1992. The major achievements in the first phase are:
The Statutory Liquidity Ratio (SLR) has been brought down from a pre-reform peak of an effective level of 37.5 per cent to an overall effective level of 25 per cent by October, 1997.
Inauguration of the business session on "Trends in International Banking" International Banking Conference organised by Indian Banks' Association at New Delhi on September 16, 1998