Malhotra: RBI Regulation Seeks Middle Path Between Stability and Innovation

The Reserve Bank of India is setting out a regulatory approach that adjusts to changing conditions, monitors emerging risks, supports innovation with clear limits, and simplifies rules while retaining essential safeguards. Governor Sanjay Malhotra outlined this direction at the Second V.K.R.V. Rao Memorial Lecture at Delhi School of Economics, describing how the RBI is shaping regulation to match the financial system’s ongoing shifts.

Malhotra said financial regulation requires a distinct approach because the financial sector is closely linked, vulnerable to liquidity pressures, and influenced by cyclical movements. Failures in one part of the system can spread quickly, making stability the RBI’s primary focus. He noted that “short term growth achieved at the cost of financial stability can have bigger consequences for long-term growth,” reinforcing the centrality of systemic resilience in the RBI’s thinking.

He explained that the RBI is moving toward principle-based regulation, which places greater emphasis on broad outcomes than on detailed prescriptions. According to him, such an approach reduces the “tick-box” mindset and limits “creative compliance.” At the same time, he said principles can be interpreted differently, prompting the RBI to use hybrid frameworks that combine broad principles with clear rule-based requirements. The expected credit loss framework reflects this mix.

Malhotra pointed to proportionality as another core element. He described it as “a customised set of risk-sensitive regulation” applied across different categories of institutions, depending on their size, structure and risk exposure. This approach is visible in the tiered norms for cooperative banks, scale-based rules for NBFCs and higher capital requirements for systemically important banks.

He noted that the RBI has formalised consultation in its rule-making process, with “every major regulation… proposed in draft form for public consultation.” This process, he said, strengthens accountability and reduces information gaps between the regulator and the regulated.

Evidence-based regulation, relying on data and observed outcomes, supports these decisions—from changes in project finance guidelines to adjustments in liquidity treatment for digital deposits.

Malhotra also described the boundary questions regulators face as new financial products and technologies emerge. Innovation frequently tests the edges of existing rules. He cited the RBI’s “cautious approach to cryptocurrencies,” alongside support for regulated digital payments and fintech activity, as an example of this balance.

He said regulations can sometimes amplify economic cycles and must therefore be designed carefully. On enforcement, he stated that forbearance should be “exceptional, time-bound, and transparent,” noting that past restructuring measures and pandemic-era steps showed when such flexibility is warranted.