Towards a Regulatory Behemoth
The final report of the Financial Sector Legislative Reforms Commission (FSLRC), recently released, has covered a wide mandate to draw a blueprint for new financial regulatory architecture. Its recommendations have got a mixed response. But these have also invited strong responses. The report had to face several dissenting views even among its members.
The FSLRC report’s recommendations are wide ranging, contentious and difficult to implement. Broadly, its recommendations are out of sync with the current Indian reality. But if ever implemented, will prove to be a potential game-changer.
Presently, consumers interact with financial firms a lot. Consumers of financial products have different degrees of protections depending on which regulator regulates a particular financial product, and are at significant risk of being mistreated by financial firms.
Highlights of Report
FSLRC would like to vest greater accountability with the government than with regulators. In its opinion, a major overhaul of India’s regulatory system for the financial sector is overdue and would be best on the lines suggested by it.
uA new regulatory entity, the Unified Financial Regulatory Agency (UFRA), to be created which will be solely responsible for the oversight of the securities market, insurance, pensions and commodities. This means, in effect this new entity will take over the functions of existing regulators including the Securities and Exchange Board of India (SEBI), the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA).
uA Monetary Policy Committee to be set up which, rather than the RBI Governor, to decide the policy rates by a majority vote.
uTo relieve RBI of its management of Capital Controls. This responsibility is connected with the current concern about management of CAD.
uTo appoint the Finance Minister as head of the Financial Stability and Development Council (FSDC).
uRBI will oversee only the banking management and its regulations and the regulation of NBFCs is proposed to be taken out of RBI’s jurisdiction.
uMost importantly, FSLRC has placed the need to protect the interests of common users of financial products and services at the very heart of financial regulation. For instance, the tests to determine where and the extent to which regulation promotes safety and soundness of financial firms ie micro-prudential regulation will be mainly rooted in consumer protection concerns. Firms such as banks and insurance companies will attract intense micro-prudential regulation, primarily because their failure harms consumers.
uIn contrast with the existing laws, the draft Indian Financial Code enunciates a detailed framework for consumer protection and lays down certain protections for all consumers. It embeds specific protections for consumers and enumerated powers to regulators to achieve this protection. The draft code will require that regulators use these powers to pursue the stated objectives through the issuance of regulations and then the supervisory process. Stronger protections are envisioned for unsophisticated retail consumers such as individuals and small enterprises. At present, to a significant extent the bulk of mis-selling goes along with bad advice.
uIn the Indian framework, the Competition Commission of India (CCI) enforces the Competition Act and brings a non-sectoral perspective to pursuit of vigorous competition in the entire economy. The draft code broadly is in sync with this arrangement and envisages improved formal mechanisms for cooperation between the CCI and various financial regulators towards achieving greater competition.
New Approach
It is, indeed, a welcome development that the FSLRC report has placed the need to protect the interests of common users at the very heart of financial regulation. Three things are important to improve the lot of consumers: regulation, competition and innovation. The draft code has featured an entirely new regulatory approach on consumer protection, which will not negate the role of the other two important pillars.
Further, recommendations made by the FSLRC report related to merging of all financial market regulators into one entity are not likely to come in the way of clearing amendments in the Forward Contract Regulations Act amendment (FCRA) Bill. This has been assured by the secretary of the ministry of consumer affairs. Argument is that since the Bill was already listed in Parliament prior to the submission of the report, it is now property of the Parliament and cannot be withdrawn simply because somebody has a different recommendation.
Transferring management of Capital Controls from RBI to Finance Ministry needs a detailed examination as over the years RBI has developed expertise in attracting NRI Deposits, FII debt and ECBs, which cannot be ignored.
It is argued in the context of setting up a monetary policy committee that many countries have created such a structure and hence is consistent with international practice. But Indian environment is different. FSLRC recommendations in this respect have ignored the Indian context.
The report’s proposals have been commented upon as highly theoretical, relevant for some ideal set of circumstances, but ignore the ground realities of the Indian institutional and governance structures.
The Road Ahead
Any radical thorough overhaul of existing regulatory infrastructure will take time and cannot be brought about immediately. Dr Subir Gokarn, former Deputy Governor, RBI, has commented that “It’s a roadmap requiring about 60 legislative changes…….If you implement some, will it work? What do you prioritize?”
Besides, the government getting the predominant power to constitute the Monetary Policy Committee requires some preconditions to be put in place like appointment processes that ensure that the best talent is brought on board, assuring that members vote on the merits of the situation and not because of any pressures from the authorities who were instrumental in appointing them and the like.
Most discussed proposal is the one to set up a new regulatory entity, the UFRA, the sole oversight body for the securities market, insurance, pensions and commodities. UFRA taking over the functions of existing regulators — SEBI, IRDA and PFRDA — would imply the financial sector comprising just two main regulators, the RBI and the proposed UFRA. Both will be expected to coordinate their activities, preferably through an MoU. Regulators then will have to work in unison for better results.
The recommendation that the principal regulators should be board driven and not follow the “top down” approach — that they are used to till now — has caused some consternation.
Major recommendation of setting up a Monetary Policy Committee which is proposed to decide on policy rates is arguably the most controversial proposal. This along with the related move to confer powers on the government to appoint members of the committee is seen as a not-so-subtle attempt to clip the wings of the RBI. The bias towards giving more powers to government becomes even more obvious with the recommendation to appoint the Finance Minister as head of the Financial Stability and Development Council. However, the RBI Governor will enjoy veto powers on interest rates under certain circumstances after it has made out a case in writing.
It is a fact that the systemic failures that have frequently occurred are more due to excessive financialisation of markets than to failures of regulation, as assumed by the Commission.
More constructive public debate on the recommendations of the report is required, which should primarily focus on the preconditions that need to be created to make each of the major proposals beneficial for the economy. The report is under examination by the government.
To sum up, according to the retired SC judge Justice B.N. Srikrishna, Chairman, FSLRC, “The new system will shake up the existing regulators…..Transition is going to be a massive problem. Unfortunately in our country you don’t notice till the water level crosses your nose.”