Raghuram Rajan was one of the few economists in the world who warned of the global financial crisis before it hit. It is now tempting to blame what happened on a few greedy bankers who took irrational risks. But, as Rajan argues in his book Fault Lines, serious flaws in the economic system are also to blame. He also warns that a potentially more devastating crisis awaits us if they aren’t fixed. Rajan shows how the individual choices that collectively brought about the economic meltdown – made by bankers, government officials, and ordinary homeowners – were rational responses to a flawed global financial order in which the incentives to take on risk are incredibly out of step with the dangers those risks pose.
The deepening fault lines have to be traced back to a world overly dependent on the indebted American consumer to power global economic growth and stave off global downturns. He shows that America’s growing inequality and thin social safety net create tremendous political pressure to encourage easy credit and keep job creation robust, no matter the consequences to the economy’s long-term health; as well as the issue that the U.S. financial sector, with its skewed incentives, is the critical but unstable link between an over stimulated America and an under consuming world. Rajan finally demonstrates how unequal access to education and health care in the United States puts us all in deeper financial peril, even as the economic choices of countries like Germany, Japan, and China place an undue burden on America to get its policies right.
Now India’s central bank governor, Rajan has promised to carry out a “dramatic remaking” of the country’s banking sector as he seeks to introduce a new era of competition in Asia’s third-largest economy. He said there would be an expanded role for foreign banks, more licenses for domestic companies and a push to shake-up the state-backed lenders.. There could be new wholesale banks, mobile phone companies carrying out banking activities, small banks, (currently not allowed), and/or co-operative banks. The measures are part of what could become one of the most far-reaching attempts to free India’s banks from the morass of state controls, introduced after Indira Gandhi nationalized many private banks when she was prime minister in the late 1960’s.