The Hindu Business Line : It’s financial circumvention, not innovation: Y.V. Reddy

Chennai, Dec. 20 Rules of the game have to change, US has to discover a different financial system due to market failure, said, Dr Y.V. Reddy, former Governor, Reserve Bank of India, during a panel discussion on ‘Causes, Effects and Crises in US Economy: Change and Management – Lessons for India’.

The crises seem to have happened in a country that has advanced regulations and advanced risk management system, he said.

The problem was not confined only to banks but spread to financial markets leading to volatility in capital markets and commodity prices. So why did the crises happen? There are three views, first the financial sector view, secondly the economist view and finally the political economic view and all three had a role to play, said Dr Reddy.

The former governor explained the financial sector credit rating agencies did not do their job right and that they were driven by incentive and greed; what was called financial innovation was nothing but financial circumvention, which led to shadow banking. What was called financial inclusion was nothing but “mis-lending”, he said.

As policy responses, the central bank had to follow unconventional measures — lowering interest rates, ushered liquidity and the Government providing outright bailout to curtail the crises, he said.

Dr Bala Balachandran, Dean, Great Lake Institute of Management, said: “We move and act on the basis of ‘fear and greed’, but the crises happened because there was no fear but only greed.”

Dr Balachandran said banks gave loans to people who could not afford them. Banks overlooked common sense by not verifying whether their customers will be able to pay a 30-year mortgage, whether they could afford it at their salary. The loans were based on credit debt swaps created by a bunch of post doctoral mathematic scholars, he said.

The current crises shows “greed” at all levels — the bankers, customers who were aware of their inability to repay. An insurance product backedthese mortgages was passed in the senate so that it does not come under the ambit of insurance regulation, he said.

Dr Balachandran said, US is the only economy to have bounced back from any crises; this will ensure that more appropriate regulation are put in place. He expected the economy to revive in another 12-18 months after Mr Barack Obama takes over as the President of US from January 2009.

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