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Challenges for the Indian Financial Code

In his Budget speech, Finance Minister Arun Jaitley indicated that several actions were being taken on the financial sector reform agenda in line with the proposals of the Financial Sector Legislative Reforms Commission (FSLRC), which recommended an overarching framework for the regulation of this extremely complex and vital sector. While some elements of this framework - for example, the new monetary policy framework, are not entirely dependent on legislative action, most of the critical ones either require amendments to existing acts or the passage of new ones. The FSLRC proposals and their operationalisation in the form of the Indian Financial Code have been in the public domain for a couple of years now; the previous government indicated that it found the overall approach acceptable and would initiate the process of putting the Code in place. The NDA government is clearly taking the same position and has imparted some momentum to the process. Correctly, specific proposals are being debated. A prominent indication of the different perceptions within the policy establishment itself are the views expressed by Reserve Bank of India Governor Raghuram Rajan. On a previous occasion, he argued that the Code in its present form would put an excessive compliance burden on financial service providers. More recently, he spoke against clauses in the Finance Bill which would have curtailed the RBI's regulatory jurisdiction over the government securities and money markets.

Divergent opinions about the merits of individual proposals are welcome. However, is the idea of a comprehensive code appropriate or ahead of its time? The main argument in favour of a holistic and integrated approach to regulation is the nature of modern finance itself. Most financial service providers and certainly all the largest ones are present in and, consequently, exposed to the risks inherent in virtually every segment of finance. Fragmented and differentiated regulatory frameworks are likely to find it difficult to maintain complete visibility across all these exposures and, therefore, provide inadequate protection to the ultimate stakeholder - the individual saver and investor. The Indian financial system comprises several components, including regulatory frameworks, that have emerged at different times and in different contexts. Bringing coherence and alignment between all these components should contribute to more effective regulation and, ultimately to greater consumer welfare and safety.

However, the process of getting to this end-point is complex and unpredictable. The Indian system has clearly not demonstrated much efficiency in effecting change through legislation. A realistic scenario is that some of the amendments and new enactments may get through, while others, which are critical to the effectiveness of the overall framework, may fall prey to the wider legislative gridlock. In this situation, the risks intrinsic to a patchy structure need to be identified and assessed. Drawing from the long-established theory of the second best, reform measures that are feasible may not be desirable if others cannot be pushed through. In finance, prudence is already a virtue. The government should keep this principle in mind, even as it works to ensure that the best possible outcome is still the main object of its efforts.