In December 2000, presenting a paper on the progress made in delivering its radical new risk-based strategy for regulating Britain’s financial sector, Howard Davies, the then chairman of the UK’s super regulator Financial Services Authority (FSA), had said financial regulation had in the past been influenced by the “dangerous dog” phenomenon. According to him, extensions in regulation had all along been imposed in response to individual crises and scandals. The Indian financial sector too has been experiencing this. The Reserve Bank of India’s (RBI) discussion paper on holding companies in the financial sector is yet another example of the “dangerous dog” phenomenon.
The provocation for the proposal, however, is no crisis or scandal. State Bank of India Ltd (SBI) and ICICI Bank Ltd, India’s two largest banks, have been planning to set up holding companies for their insurance and mutual fund businesses. Under existing laws, a commercial bank cannot invest more than 20% of its capital and reserves in its financial services subsidiaries. Since the life insurance business needs huge capital at the initial stage, both the banks plan to use the holding company to raise the money from the market or private equity investors. In technical terms, this is an “intermediate” holding company between the parent bank and its financial services subsidiaries.
RBI is distinctly uncomfortable with the idea of an “intermediate” holding company as regulating such a holding company will be difficult with its subsidiaries coming under various regulators. Its suggestion is fairly simple: go for a banking holding company or a financial holding company. The banking holding firms can own more than one bank and make limited investment in non-banking companies while the financial holding firms can own banks as well as non-banking businesses.
If banking conglomerates such as SBI and ICICI Bank want to float holding companies, it can be done by amending the law that governs Indian banks. However, if they want to float financial holding companies, the government would need to create a new legal framework along the line of the Gramm-Leach-Bliley Financial Services Modernisation Act in the US. The primary supervisor for the holding company should indeed be RBI but what about a financial holding company that will have exposure to insurance, capital markets, pension funds and so on?
This brings us to the crux of the problem—the presence of multiple regulators in the Indian financial sector. While banks and institutions enjoy regulatory arbitraging, the regulators often find it difficult to supervise the sector. The holding company concept will not address the issue. At best, it’s like using a Band-Aid for a serious fracture.
Take the case of SBI, the country’s largest commercial bank that roughly accounts for one-fifth of the Indian banking industry. It is subject to RBI regulations for its commercial banking activities; its investment banking arm SBI Caps and asset management firm SBI Mutual Funds are supervised by the Securities and Exchange Board of India (Sebi); and its general insurance arm is regulated by the Insurance Regulatory Development Authority (Irda). As and when the bank makes its foray in the pension segment, it will have to report to yet another regulator.
RBI oversees commercial banks, non-banking financial companies and urban cooperative banks. It also indirectly supervises regional rural banks and central and state cooperative banks, state financial corporations and housing finance firms through National Bank for Agriculture and Rural Development (Nabard), Small Industries Development Bank of India and NHB—all RBI arms. The Registrar of Cooperatives (RoC) of different Indian states is a joint regulator for cooperative banks. Sebi regulates capital markets and supervises stock exchanges, asset management firms, brokerages, investment banks, foreign institutional investors and venture capital funds while Irda is the watchdog for the insurance business. Finally, the government’s department of company affairs (DCA) regulates the deposit-taking activities of non-banking, non-financial companies.
There is coordination among different regulators. For instance, there is a panel on capital markets, headed by the RBI governor, that meets regularly to discuss market-related issues. Chiefs of Sebi, Irda and the country’s finance secretary are members of the panel. The nominees of the ministry of finance and DCA, as well as a deputy governor of RBI are on the board of Sebi, while the finance secretary is a member of RBI’s board, albeit without voting rights.
However, these mechanisms cannot prevent regulatory arbitrages as, apart from the presence of too many regulators and legislations, there are divergent norms that govern the financial sector. For instance, foreign holding norms in public and private banks are radically different.
The ideal solution could be a single regulator or even a super regulator. RBI should have thought of this five years ago when it allowed financial institution ICICI to convert itself into a universal bank—a one-stop financial shop. The Monetary Authority of Singapore is the sole regulatory authority for the entire financial sector in Singapore. The UK, Japan, Korea and Sweden have unified regulators outside the central bank. India can explore one of the two modelsm—making RBI the sole regulator or creating a super regulator outside the central bank. But to do that, the finance ministry, the uncrowned super regulator of the Indian financial system, first needs to give up its authority.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai Bureau Chief of Mint. Please email comments to email@example.com