Passage

Financial markets in India have acquired greater depth and liquidity over the years. Steady reforms since 1991 have led to growing linkages and integration of the Indian economy and its financial systems with the global economy. Weak global economic prospects and continuing uncertainties in the international financial markets have had an impact on the emerging market economies. Sovereign risk concerns, particularly in the Euro area, affected financial markets for the greater part of the year, with the contagion of Greece’s sovereign debt problem spreading to India and other economies by way of higher-than-normal levels of volatility.

The funding constraints in international financial markets could impact both the availability and cost of foreign funding for banks and corporates. Since the Indian financial system is bank-dominated, banks’ ability to withstand stress is critical to overall financial stability. Indian banks, however, remain robust, notwithstanding a decline in capital to risk-weighted assets ratio and a rise in non-performing asset levels in the recent past. Capital adequacy levels remain above the regulatory requirements. The financial market infrastructure continues to function without any major disruption. With further globalization, consolidation, deregulation, and diversification of the financial system, the banking business may become more complex and riskier. Issues like risk and liquidity management and enhancing skills, therefore, assume greater significance.

Question

CSATEasyPrelims 2013Comprehension

According to the passage given above, in the Indian financial system, banks’ ability to withstand stress is critical to ensuring overall financial stability because the Indian financial system is:

Explanation

Statement 1 is incorrect. This is not mentioned in the passage. While the government may have regulatory influence, it is not stated to "control" the financial system.

Statement 2 is incorrect. This contradicts the passage, which states that the system is bank-dominated, meaning it is more integrated with banks, not less.

Statement 3 is incorrect. The Reserve Bank of India regulates the system but doesn't dominate it. The passage highlights the dominance of banks, not the RBI’s control.

Statement 4 is correct. The key phrase here is “bank-dominated,” which implies that banks play a dominant role in the financial system. As a result, the stability of the banking sector directly affects the stability of the entire financial system. Thus, banks' ability to endure economic stress and remain solvent is crucial.