RBI Governor stresses need for financial system that withstands external shocks

Reserve Bank Governor Sanjay Malhotra articulated five principal considerations for policymakers in maintaining financial stability. Recognizing the inevitability of certain shocks, he emphasized that financial stability is not predicated on preventing them, but rather on bolstering systemic resilience to withstand such events and mitigate their propagation. Shocks can be either endogenous or exogenous. The objective should be to cultivate a financial system capable of delivering financial services across all economic conditions, even during periods of acute stress. Secondly, a novel cohort of systemic risks is emerging, according to the RBI Governor, underscoring the importance of evaluating these risks and their intricate relationships. Risks are progressively exogenous, cross-border, and interconnected; the subsequent financial crisis may not originate within a banking institution, or even within the financial sector itself. It could commence with a geopolitical event, a cyberattack, or a technological failure, impacting the financial system through multiple channels.

To bolster systemic resilience, it is imperative to deepen the comprehension of interconnected dependencies and contagion pathways, establishing scenario analysis as a core element of risk management, he stated. Furthermore, we must refine monitoring and assessment methodologies, necessitating enhanced and more detailed data. The financial system’s escalating complexity is juxtaposed with fragmented data regarding NBFIs, interconnected exposures, technological dependencies, and cross-border positions. He observed that, within an increasingly interconnected financial system, data quality will progressively dictate the caliber of risk assessment. Fourthly, resilience necessitates a system-wide approach. While a robust banking sector is essential, it remains insufficient. Resilience is required across sectors and institutions: NBFIs, financial markets, payment systems, technology infrastructure, critical third parties, and cross-border financial networks. Financial instability in any locale can rapidly evolve into a threat to global financial stability, he added.

The official emphasized that innovation should reinforce, rather than undermine, the bedrock of trust. Artificial intelligence, tokenization, and novel forms of financial intermediation possess the potential to substantially enhance efficiency. However, innovation’s longevity will depend on the financial system's preservation of core tenets that underpin trust: robust institutions, settlement finality, singleness of money, and financial integrity. The present challenge involves constructing a financial system capable of withstanding anticipated and unforeseen shocks. This necessitates resilient institutions, enhanced data, deeper markets, credible safety nets, effective resolution frameworks, and proactive, forward-looking regulation and supervision that remain proportionate. Should these objectives be achieved, financial stability will remain largely imperceptible. And, within central banking, such inconspicuousness represents perhaps the most significant indicator of success.