Exemplary regulation in India!

Talk of regulation in India, and people generally think of red-tape and outdated rules. However, in recent times there has been an instance of exemplary regulation in India that should serve as a good example for the other countries of the world to emulate.

The regulator for the Indian banking system is the Reserve Bank of India ( RBI ). Dr. Y. V. Reddy was the governor of RBI from 2003 to 2008. Regulators can detect the building up of bubbles in the economy and make sure they are dealt with early on. Or they can provide support to the economy once the bubble has burst. Most regulators globally have been very good with the second aspect. However, in India’s case the regulator correctly detected a build up of the housing bubble and took corrective action, thus making sure the second stage wasn’t necessary.

By 2006-07 the Indian housing market (like the Indian stock market) was going through the roof. Dr. Reddy and the RBI detected the housing bubble early on and used a slew of policy measures to control it:
Banned the use of bank loans for the purchase of raw land: Land prices were going through the roof and if prices collapsed, banks would then end up with huge non performing assets. Hence RBI stopped banks from making these loans.
Increased risk weightings on commercial buildings and shopping mall construction, doubling the amount of reserve capital: Banks were made to put aside extra capital for every loan made. Anticipating a liquidity crisis, the RBI was mandating banks to plan for it ahead of time.
Severely limited securitization: Banks in India were not allowed to simply bundle up their home loans and sell them off to a third party. Thus, banks ended up holding onto the loans they made to customers. Banks, in this case, had a high incentive to make sure the loans were repaid. Hence the lending standards were not relaxed to absurd levels and also the down-payment requirements were conservative.
Pushed interest rates up: Last but not the least, the RBI pushed key interest rates up early on to prick the housing bubble before it could get out of control.

The housing market did crash in 2008; however, thanks to the early actions of the banking regulator, the Indian banks did not have to write down huge amounts of money. Neither did any Indian bank fail, or require the kind of emergency injections of capital that Western banks have needed. What a huge difference good regulation can make!




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This post presents a point of view which differs from conventional wisdom. Apart from being a good read (hopefully), it can be a good starting point to help readers, preparing for CAT (IIM) or other MBA interviews, think differently. Since the data / facts for these posts are derived from a host of sources and websites, readers are advised to cross-check the authenticity before using them anywhere.