Should there be any restrictions on any financial sector post-convertibility?

In the international experience, the weakest link tends to be banking. Banks have very high debt; they have a debt-equity ratio of 20. This extreme leverage goes with extreme risk. Slight mistakes by a CEO can lead to bankruptcy. As an example, banks themselves generally refuse to lend to a private company which has a debt equity ratio of more than 2. Though the level of loans gone bad (non performing assets) with banks in India is not very high, it is well understood that the incentive structure of a bank owned by the government could be warped. It knows that it will not be allowed to go bankrupt. This is a serious problem in India, where 80 per cent of bank deposits are with PSU banks.

A bank could easily take on a lot of currency risk. So, for example, a bank could borrow cheaply abroad in yen and lend at much higher interest rates in India. Its calculations about the profits it expects to make could go horribly wrong if the yen-rupee exchange rate changes drastically. Since the government owns these banks the foreign loans taken by them are effectively loans taken by the government, which will stand by and honour them.

Hence, the safe thing for India to do is to move forward on all aspects of convertibility now, but retain tight controls on the globalisation of banking for a few years.