Raghuram Rajan, who has also served as Chief Economist at the IMF, said the greater demand on banks to hold capital in the post-financial crisis scenario has come at a cost.
Bankers may have a low credibility for having "cried wolf too often", RBI Governor Raghuram Rajan said even as he appeared favouring their case for easing of strict capital control measures to boost growth.
The outspoken Governor also likened the situation in India to that of small and medium enterprises (SMEs) in industrial countries, saying a need for faster growth is the central factor in both scenarios.
Rajan, who has also served as Chief Economist at the IMF, said the greater demand on banks to hold capital in the post-financial crisis scenario has come at a cost.
"It made sense post financial crisis to ask banks to hold more capital. But one of the concerns bankers have been expressing, even if bankers may have low credibility because they have cried wolf too often, that eventually it will...create greater aversion to taking on risky lending."
"We see some of that today. Certainly, as an emerging market central bank regulator, I see that foreign banks have stopped opening branches because our credit rating is BAA, which implies higher risk. From that perspective, international banks who are asked to put in money in India feel it is not worth it, because they have to set aside a lot more capital."
India has been assigned the lowest investment grade rating with a high risk profile by various global agencies.
Rajan was delivering a lecture titled 'Why Banks?' as part of the Marshall Lecture 2015-16 series at Cambridge University last evening.
Talking about growth and capital flows, he said, "So we need to ask ourselves, is more capital good or is it likely to impinge on activities banks do. There is a trade-off and this calls for more empirical work as to what the right level of capital is."
Rajan, on-leave Professor of Finance at the University of Chicago's Booth School, used what is described as "matchstick theory" in an attempt to highlight why doing away with banks was not essentially a viable option.
Addressing a largely student and academic audience of the two-day lecture series organised by the university's Faculty of Economics, he said, "There is a reason why banks operate.
All these proposals to do away with banks, to my mind, will cause serious costs on the system, it will increase the cost of financing and therefore we have to be very careful.
"However, we do understand the consequences of systemic crises, they are severe, they are painful so more capital was warranted than what there was during the global financial crisis, but we have to be careful about going too far."
