regulation and superVISIOn of financial institutions

regulation and superVISIOn of financial institutions and markets; crisis management and provision ofliquidity; and macrofinancial stability encompassing monitoring not only the behaviour of all important players in the financial sector but also non-financial sector balance sheets as well as those of the governments.
7.4 The financial turmoil that began to unfold in August 2007 - widely known as the sub-prime crisis­has brought financial stability issues to the forefront of policy discussions. The turmoil was a fallout of an exceptional credit boom and leverage in the financial system. On a hindsight, the present crisis appears to be a result of a macroeconomic environment with a prolonged period of low interest rates, high liquidity and low volatility, which led financial institutions to underestimate risks, a breakdown of credit and risk management practices in many financial institutions, and shortcomings in financial regulation and supervision3• A slowdown in the US real estate market triggered a series of defaults and this snowballed into accumulated losses, especially in the case of complex structured securities. The US subprime crisis has led to both the strained conditions of financial markets and the slowdown of the broader economy. The US economy continues to confront substantial challenges, including stresses in financial markets, a weakening labour market and deteriorating economic actIVIty. The problems intensified significantly around mid-September 2008, when major losses led to failure of major financial institutions. The recent troubles at Lehman Brothers, Merrill Lynch, and Fannie Mae and Freddie Mac suggest the deep rooted problem in the global financial markets that the authorities have to address.
7.5 The ongoing financial turmoil took a serious turn when major financial institutions started experiencing extreme degrees of difficulty. Bear
Stearns was the big first wall street investment banks of the five to collapse in March 2008, followed by the filing of chapter 11 bankruptcy petition by Lehman Brothers Holdings ine. and the sale of Merrill Lynch to Bank of America in September 2008. The remaining two, Goldman Sachs and Morgan Stanley, have abandoned their once-cherished investment bank business model to become bank holding companies to secure greater Fed protection and to soothe negative market sentiments. This was soon followed by the takeover of the sixth largest bank, Wachovia, by the CitiGroup. The recent turn of events prompted the US Government to come out with a $700 billion bailout package for banks to buy the distressed assets. Full prudential supervision and regulation at the hands of the central bank and the Federal Deposit Insurance Corporation would provide them access to permanent liquidity and funding by the Fed. Though the Fed had allowed investment banks to access discount window financing since Bear Stearns crumbled, this source was set to close at an unspecified point in 2009. The Securities and Exchanges Commission (SEe) was previously responsible for the supervision of the investment banks under the voluntary consolidated supervised enterprises regime. Lighter regulation of investment banks had enabled the industry reap greater rewards than their commercial banks counterparts in the boom preceding the credit crisis. But the crunch has revealed the drawbacks of the industry's high-risk strategy. The shocks in the US financial system have reverberated in some European countries as well such as the UK, Switzerland and Germany. Though the direct impact on India and other Asian emerging market economies (EMEs) was muted, the indirect impact has been significan t.
7.6 The initial impact of global financial contagion in India, however, has been limited for a variety of reasons. India's growth process has been largely