'Regulatory lapses to blame for crisis'

MUMBAI: Outgoing Reserve Bank of India deputy governor Rakesh Mohan has called for greater focus on loan-to-value ratios (LTV) for mortgages by central banks to ensure financial stability.

In a paper on the financial stability review for the Bank of France, Mr Mohan has underscored the need for regulators to ensure that the mortgages extended by banks are a fair proportion of the value of the property. The paper, written against the backdrop of the global financial crisis, traces the origin of the crisis to regulatory lapses in the mortgage market. Various studies have found that loans have been up to 100% of the value of the property. This was found to be a major contributing factor to the crisis.

Mr Mohan also said rating agencies will have to be subject to a regulatory oversight regime. Their practices and procedures for managing conflicts of interest need to be modified for assuring the transparency and quality of the rating process, particularly on the process underlying ratings of complex securitised instruments and derivatives.
The outgoing RBI deputy governor also called for enhancing international standards for capital.

He pointed out that liquidity buffers will have to be enhanced once the financial system improves. Besides, a build-up of capital buffers and provisions in good times should be encouraged so that capital can absorb losses and be drawn down in difficult times such as the current period.

Regulators will need to do significant technical work in the understanding of business cycles so that turning points can be recognised. What would be the triggers for changes in these capital buffers in either direction? Would these changes kick in in anticipation of business cycle turns or post facto? How formation or rule-based would these changes be so that regulated institutions know in advance themselves what they need to do?

The deputy governor���s observations are in line with other major international post-crisis reports. For instance, the report by Lord Turner, chairman of the UK���s Financial Service Authority, has observed that the crisis-affected countries have not paid attention to LTV and hence called for regulators��� attention to this parameter.