 "Regulations")
The Reserve Bank of India (RBI) last week uploaded an innocuous-sounding document on its website called the “Framework for Formulation of Regulations”. It went largely unnoticed. In the field of regulation, however, it is a development of profound significance.
The essence of the state is its monopoly on violence and the exercise of coercive power. In democracies, state coercion is permissible only with the authority of law — and that law is required to be backed by democratic legitimacy. Democratic legitimacy in coercion is born of legal procedures and norms. The Indian Constitution prescribes an elaborate process through which state coercion can take place. Alongside this, norms such as expert and parliamentary committees, and consultations with stakeholders also shape the outcome.
Statutory Regulatory Authorities (SRAs) are a major author of law in India today. They have been given the power to legislate — that is, to write legal instruments that demand certain behaviour of private persons, with penalties associated with non-compliance. The impact of this power on regulated entities is exactly like the impact of laws made by legislature.
For example, the Securities and Exchange Board of India (Sebi) has made regulations on the subject of insider trading. Violating these regulations can result in severe penalties, including fines of up to ₹25 crore, imprisonment, and restrictions on trading in the securities market. In the financial sector alone, it is estimated that about 10 “laws” are released every working day by all financial agencies put together.
The exercise of such power by SRAs contains an inherent “democratic deficit”. In a liberal democracy, unelected officials ordinarily should not have the power to write law. To take an example, the Sebi Act requires that these regulations be made by the Sebi board. However, it is silent on how these regulations are to be written. As a consequence, laws are regularly being promulgated by regulators such as Sebi without the rigour of a democratically legitimate legislative process.
Fourteen years ago, in 2011, the Government of India (GoI), constituted the Financial Sector Legislative Reforms Commission (FSLRC). Chaired by a retired Supreme Court judge, its members included economists, bankers, lawyers, and public administration experts. The FSLRC submitted its report in March 2013. This was put through a process of public consultation, and two additional years were taken in responding to the volume of public comments. Overall, the FSLRC was a four-year project that led up to one high-quality draft law.
This law contains three components: (a) About 140 sections of law, which define how regulators must work; (b) an improved financial agency architecture — of the agencies that must exist and the work that must be allocated to them; and (c) a detailed statement of the tasks that must be carried out for financial and monetary economic policy by the various financial agencies.
This high-quality draft law — the draft Indian Financial Code (IFC) — was not enacted as law. The simple theory of change — that a vast effort by the research and reform community would lead to one draft law getting enacted — proved not to work. However, the work of the FSLRC has had enormous influence and has reshaped the paradigm of financial economic policy in India. One by one, building blocks from it are turning into reality.
The FSLRC had envisioned unification of the regulation of all organised financial trading. This required the merger of the erstwhile Forward Markets Commission into Sebi. This was done in 2013. The FSLRC had envisioned a modern system of accountability for monetary policy — that is, inflation targeting, with dispersion of power — that is, the monetary policy committee with greater non-government presence. This was done in 2015-2016. The FSLRC had envisioned the Securities Appellate Tribunal (SAT) would be the forum where appeals against all financial SRAs would go. This has been done for all financial SRAs other than the Reserve Bank of India.
For the legislative function of SRAs, the FSLRC recommended that the democratic deficit should be overcome through the role and composition of the board, through expertise, and through consultation. The regulator must articulate the objective of a regulation, the market failure that the regulation seeks to address, and show cost-benefit analysis of multiple possible interventions leading to the choice of the lowest-cost intervention. Public consultation is required, and then only the board (which should have a majority of non-civil-servants) can authorise all laws. Such a process would improve the content and legitimacy of the law.
As noted, the FSLRC’s IFC was not enacted as law. But there are ways to make progress nonetheless. The Insurance Regulatory and Development Authority of India was the first off the block and established a self-imposed mechanism for framing regulations in June 2016. The newly constituted Insolvency and Bankruptcy Board of India issued a mechanism for this purpose in 2017. The Pensions Fund Regulatory and Development Authority issued this mechanism in 2024. Sebi waited one more year, and got there three months ago. Finally, the RBI issued this framework last week.
This gives us insights into the theory of change. Practical people in government often say that they don’t need advice of external experts as they have knowledge of real-life conditions and are not ivory-tower, armchair theorists. The actual history of economic reforms in India is entirely the story of the research and reform community, a procession of expert committees.
The FSLRC itself represented the fruits of the labour of a research and reform community that had been in motion since the early 1990s. Great progress was made on the ideas in the 2011-2015 period, with debates and consensus within the FSLRC. The ideas were translated into documents, papers, blog articles, videos, and more. The ideas gradually persuaded people and reshaped the environment. The norms on democratic legitimacy in regulation in India have changed, through this long journey. The next 10 years will now be about refining these self-imposed processes for writing regulations, building capability inside each financial SRA to live up to the thorough procedure, and codifying these procedures into parliamentary law.
The author is an honorary senior fellow at the Isaac Centre for Public Policy, and a former civil servant
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
