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Centre set to form financial stability panel

Centre set to form financial stability panel
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First Published: Sun, Sep 12 2010. 10 38 PM IST

Updated: Sun, Sep 12 2010. 10 38 PM IST
New Delhi: Overriding the reservations of the Reserve Bank of India (RBI), the finance ministry will set up a council this fiscal that will be tasked with maintaining financial stability and developing financial markets, taking on a role the central bank believes is its preserve.
The Financial Stability and Development Council (FSDC) will be headed by finance minister Pranab Mukherjee, who outlined the proposal in his budget speech, saying it would “help to strengthen and institutionalize the mechanism for maintaining financial stability”.
FSDC’s creation will be the second key change in the framework that governs India’s financial sector. The views of some experts, including two former central bank governors, reflect a sense of unease in the way the financial sector’s institutional structure is evolving.
“This is an important institutional change in the regulatory structure of the financial system with long-term implications,” former RBI governor Bimal Jalan, who also worked in the finance ministry, wrote in a recent column in the Business Standard.
According to a senior finance ministry official, who did not want to be named, FSDC would create an institutional mechanism that would reflect reality. This reality is that the legislature, through its representative, the finance minister, is ultimately responsible for maintaining financial stability and propel financial market development, the official said.
FSDC will not be a legislative body, and can be created through an executive order. Work on establishing it is under way and it will be formed before the end of the current fiscal, said the official, who didn’t want to be named.
In June, the Union government promulgated an ordinance, replaced later with a Bill passed by Parliament, to resolve turf battles between the four financial sector regulators. A joint committee headed by the finance minister and composed of the heads of the regulatory agencies would resolve such disputes. The move followed a turf war between the capital market and insurance regulators.
Around that time, the government also circulated a discussion paper on FSDC.
Both developments made RBI uneasy as the central bank felt they had the potential to erode its autonomy. Although Mukherjee has repeatedly said none of the proposed changes are aimed at undermining regulators’ autonomy, the sense of unease remains among some experts.
FSDC, as proposed in the discussion paper, will not be a super-regulator. It will be chaired by the finance minister and will have two committees, one on regulatory coordination under RBI and the other on financial sector stability under the finance secretary. FSDC’s secretariat will be housed in the finance ministry, the discussion paper said.
There are two main points of concern about the proposal. FSDC’s scope includes macro-level supervision to identify risk and maintain financial stability.
So far, RBI has interpreted the existing legislation as entrusting it with primary responsibility for stability, according to an essay on the subject by former RBI governor Y.V. Reddy in Economic and Political Weekly (3 April).
Finance ministry officials have repeatedly made the point that in all financial crises, including the last one in September 2008, the finance minister is the one who has been at the forefront of coordinating different stakeholders to find a solution.
The finance minister is also the only person who can authorize the use of taxpayer money as a part of the solution.
This is a general principle as even after recent reforms to regulatory and supervisory architecture in the financial system, both the UK and the US have kept the treasury in charge of all coordination moves at times of crisis.
The central bank is also at the heart of any crisis management as it can quickly expand its balance sheet, as the US Federal Reserve did in 2009, or has the capability to provide a cushion to vulnerable entities, in the manner RBI helped mutual funds in 2008-09.
In the FSDC context, the structure of the proposed body may have made RBI wary. In its annual report for 2009-10, released last month, RBI said: “There has to be clear recognition that committees cannot assume executive responsibility for financial stability, especially in a crisis situation where speed and surprise could be the key elements of response.”
Another change in the institutional structure proposed by FSDC that some experts are wary of is its development agenda. The discussion paper on FSDC said there “is a need for an institutional mechanism that can coordinate and oversee the reform and development agenda for the financial markets as a whole”.
There is wariness about FSDC’s development agenda as it would upset the balance of power in introducing financial innovation and policy making.
Given the different goals of stakeholders in financial sector regulation and development, when the balance of power is tilted towards politicians, a short-term view of the situations could prevail, some experts say.
FSDC could accidentally create a situation where much of two decades’ reform in the financial sector could be undone, they say.
Historically, there have been differences between RBI and the finance ministry on the speed with which innovation should be introduced. Banks dominate India’s financial landscape and RBI, as their regulator, influences the pace of change.
Reddy, in his essay, pointed to an occasion when RBI checked the pace of innovation because it was wary of the results.
“While public policy was in favour and the securities regulator was keen to develop the derivatives market, RBI by its unique position was able to moderate the pace of such innovations to suit Indian conditions,” Reddy wrote.
FSDC will change the equilibrium, which is what some experts are wary of.
“The potential danger in setting up a committee of this type is that it confers powers on the government to formally intervene in financial regulatory issues, including monetary policy, if it so decides some time in the future,” Jalan wrote.
Renu Kohli, an economic consultant who has worked with RBI and International Monetary Fund, said one should be mindful of the historical context when creating institutions.
“It is not clear as to what the immediate provocation is (for creating FSDC),” she said. “The buck has always stopped with the ministry.”
sanjiv.s@livemint.com
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First Published: Sun, Sep 12 2010. 10 38 PM IST