Proceeding with caution

As financial systems around the world are being subject to intense scrutiny, the regulatory pendulum appears to be shifting towards greater govt

The Committee on Financial Sector Assessment, chaired by Rakesh Mohan of the RBI, submitted its report on Monday. The group was set up in 2006, before most people had any inkling of the crisis that was to hit the global financial system. Since much of the committee’s activity has taken place under the shadow of the crisis, there is every possibility that it would have had doubts about recent reform roadmaps that pushed for a far greater play of market forces. As financial systems around the world are being subject to intense scrutiny, the regulatory pendulum appears to be shifting towards greater government intervention in terms of both ownership and restrictions on activities.

To its credit, the committee has resisted the temptation to play to a populist gallery. Dr Mohan has a reputation as a committed but pragmatic reformer. That position runs clearly through the committee’s recommendations on a variety of issues. The central theme is an acceptance of the fact that the Indian financial system needs substantial reforms, regardless of what has happened over the past year or more. But, in the wake of the global crisis, reform is seen to have two distinct dimensions. The quest for greater efficiency in financial intermediation needs to be balanced with the capacity to identify and protect against risks.

Among its more salient recommendations is the one that asks for government shareholding in banks to fall below 51 per cent, thus providing these banks the room to expand their capital base without relying on public funds. Since this is unlikely to be bought by the political class, the committee has suggested a practical way to accomplish the end objective: consolidate banks which have high government stakes with those that have diluted it over the years. It goes without saying that any such consolidation needs to keep potential synergies in mind. However, the need to have larger banks with a greater degree of managerial autonomy cannot be questioned, even as tighter prudential management may be granted. Similarly, the committee endorses the gradual approach to “fuller” capital account convertibility recommended by the second Tarapore Committee—a position that will be generally accepted because the “full” convertibility position now has far fewer takers than before. On some other issues, the committee’s recommendations require debate.

The committee calls for the centralisation of regulatory supervision of financial conglomerates under the RBI. While this is not unreasonable, it would require a corresponding increase in the capacity of the RBI itself, enabling it to monitor activity beyond conventional banking. To create this capacity it would have to re-think its human resource strategy. Further, the committee is critical of banks lending below their stated prime lending rates. While this practice may seem like a contradiction in terms, it probably has its origins in some rigidities introduced by the government when it comes to rural lending. As for the role of foreign banks, the Committee has done well to emphasise reciprocity—the same countries that deny branches to Indian banks have been the most vocal in demanding more branches for their banks in India. However, reciprocity can also be a sub-optimal game—one reason why India has chosen to unilaterally drop tariffs well below the “bound rates” negotiated at the WTO. If it serves the economy to allow a greater presence for foreign banks, that should dictate policy more than reciprocity.