Honorary Visiting Professor, Indian Statistical Institute, Delhi
Another layer on top of the existing regulators will reduce the speed of response as well as accountability. In any case, the current system has worked well for us
The announcement in the Union Budget 2010 of a Financial Stability and Development Council (FSDC) follows the suggested changes to the regulatory architecture prescribed by the Raghuram Rajan Committee on Financial Sector Reforms, which submitted its report on September 12, 2008 — just a few days before the great crash. Although the Committee prefaced its recommendations by saying that it was “premature to move fully towards a single regulator at the moment”, a unified regulatory structure was clearly the goal towards which the Committee thought regulation in India must begin to move.
The principal argument advanced by the Committee in favour of unified regulation is that it is needed to combat financial conglomerates and holding companies as they begin to dominate the system across financial spheres. At the same time, the Committee adopts the contradictory stand that a unified regulator is less vulnerable to capture because it faces countervailing pressure from different segments of the regulated. Arguing from first principles, regulatory capture is actually that much easier when a single regulatory fortress is all that needs to be stormed. In developing countries with a democratic structure, and political parties in need of election funding, a unified regulator is a disturbing prospect.
In the B.C. (before crisis) era, unified regulation was the flavour of the time, and the UK went ahead and did precisely that. Prudential regulation was gouged out of the Bank of England, and merged into a single regulator, the Financial Services Authority. The crisis demonstrated the folly of separating prudential regulation of the banking sector from the central bank’s role as lender of last resort. That lesson has fortunately not been lost. It is fully expected that prudential regulation of banks will soon be restored to the Bank of England. Regulation in the US, on the other hand, was not unified, and the structure there did not shine either. It collapsed more utterly than elsewhere. No single model emerges unscathed from the empirical test of the great crisis.
That leaves us with the task of thinking through the regulatory structure that will best suit us. The Raghuram Rajan Committee recommended two distinct bodies. A Financial Sector Oversight Agency (FSOA) was suggested, for risk assessment and co-ordination across regulatory spheres, to be chaired by the senior-most regulator. A Working Group on Financial Sector Reforms was also suggested, with the finance minister as chairman, and regulators included in the membership. The danger is that these two quite separate recommendations will in practice be conflated into a single body, chaired by the finance minister. Political chairing of a co-ordination council is a troubling arrangement. An apolitical institutional mooring is needed for long-term financial stability, so central to the lives of all Indians whether or not they are directly linked to the formal financial structure.
Informal co-ordination and discussion across regulators are certainly good, but this already existed at the time of the Raghuram Rajan Committee, and are mentioned in its report. There is the High Level Coordination Committee (HLCC) on capital markets, supplemented by operational coordination between regulators. All the financial regulators in place — RBI, Sebi, Irda and PFRDA — have defined mandates and powers. If a further legislated layer is superimposed, a loss of accountability is foreseeable. Given the Indian penchant for ceding all power upwards, it is clearly possible that speed of response, an essential feature of effective regulation, will be lost as regulators seek and await approval from the highest layer.
The Financial Council that has been proposed is a solution to a problem that does not exist. During the crisis, India earned universal admiration for the robust shield surrounding its regulatory structure. Friends of India will watch with horror if we tamper with the very edifice which held us up so well.
The Budget announcement of a Financial Sector Legislative Reforms Commission, on the other hand, is a good idea. There is most certainly legal untidiness that needs cleaning- up, and if in the process pending cases before the clogged judicial system are also resolved, a huge source of friction standing in the way of financial sector advancement will have been addressed.
Chairman, Damodaran Group
The HLCC hasn’t been able to resolve issues between regulators — an FSDC chaired by the FM would fix this and also ensure their autonomy is preserved
In a Budget speech mercifully devoid of flights of fancy and purple prose, the announcement of a Financial Stability and Development Council (FSDC) stands out in splendid isolation. The carefully crafted paragraph sets out multiple objectives, seeming to strengthen the suspicion that even the authors of the proposal were not entirely convinced of the need for the proposed Council. Some of the post-Budget explanations have tended to further cloud the issue.
It seems near-certain that the Council would have as its members the regulators in the financial sector as well as the finance secretary and would be chaired by the finance minister. The stated intention being to “strengthen and institutionalise” the existing mechanism, the High Level Coordination Committee (HLCC), comprising all the financial sector regulators and the finance secretary, should be simultaneously disbanded. The Council is expected to “monitor macroprudential regulation of the economy”. Post-Budget explanations have it that the Council would bring to the notice of the regulators the emerging trends worldwide and the likely impact on the Indian economy and the financial sector. This should not have been beyond the competence of the HLCC, if it saw itself as appropriately tasked to do so. The proposed monitoring of supervision, “macroprudential” or otherwise should legitimately raise eyebrows. Is that why the Budget took care to say the functioning of the Council would be “without prejudice to the autonomy of regulators”?
What seems most bizarre is a recent explanation that in the context of the “global” financial meltdown, developed economies are coming up with new institutions or mechanisms as regulatory responses and, therefore, we need one of our own — it would be reasonably clear that the regulatory responses of the developed world have been deficient, ill-conceived or excessive, and there is no reason for us to take a leaf out of their book to redesign our regulatory architecture.
The proposed Council’s “focus on financial literacy and financial inclusion” merits a brief comment. It, almost certainly, will lead to a lack of focus on the principal objectives with which the Council is being set up.
Notwithstanding these doubts and reservations, the Council isn’t such a bad idea. The HLCC, comprising all the relevant regulators, has not covered itself in glory in sorting out turf issues. It was unable to create the space that the Securities and Exchange Board of India (Sebi) needed as a functional regulator of the debt market, because banks were major players, and the RBI as entity regulator was unwilling to give up what Sebi saw as its legitimate turf. That the issue found some resolution subsequently is no thanks to the HLCC. Recent developments over unit-linked insurance plans have given rise to reports of divergence of views between regulators, and there is no evidence that the HLCC has found any solution. The proposed FSDC, with the finance minister as its chairman, would be far better placed to facilitate a decision on the way forward — the absence of regulatory coordination is a luxury that no nation can afford.
There is also the question of the functional autonomy of regulators. Autonomy is what one exercises in bona fide discharge of one’s functions. It is not the handout of a satisfied superior to a supplicant subordinate. Therefore, the apprehension that the Council would automatically have an adverse impact on the functional autonomy of regulators is not well-founded. A council headed by the finance minister could well be the best insurance against attempts at middle levels in the ministry to interfere with the autonomous functioning of regulatory organisations in the name of, but not at the instance of, the minister.
The remit of the Council should be unambiguously articulated, so that there is no temptation for regulators to shy away from decision-making and seek comfort in endorsement at “higher levels”. Notwithstanding what is contained in the Budget speech, the Council should not take upon itself the monitoring of the supervision of large financial conglomerates.The ministry could then become the first port of call and that is best avoided. The institution of a lead regulator, based on the predominant activity of each conglomerate should suffice. Also, if stability is the primary objective, the commodity market regulator should have a place in the Council.
The Council is not such a bad idea. Let’s give it a chance — without prejudice.
The author is former Sebi chairman
In spite of the RBI's rate cut and the Centre's reforms, any recovery will only be half-hearted