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Business News/ Opinion / What the US Fed needs to learn from RBI
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What the US Fed needs to learn from RBI

The culture of deference towards regulated entities is unimaginable in India

Illustration: Jayachandran/MintPremium
Illustration: Jayachandran/Mint

Last weekend, the US financial sector was rocked by the explosive revelations of Carmen Segarra, a former employee of the New York Federal Reserve, about the inner workings of the US Federal Reserve. Segarra was part of a team of Fed officers who were assigned to examine the operations of Goldman Sachs. Segarra’s secretly taped conversations with colleagues and her revelations, corroborated by the ProPublica investigative journalist Jake Bernstein, showed that instead of taking Goldman to task for its regulatory violations, Fed officers deliberately underplayed such violations, and sometimes dismissed them altogether.

Segarra, who worked for less than a year at the Fed, was astonished by the culture of deference in the organization towards Goldman Sachs. When she found that Goldman lacked an effective policy for conflict of interest, she was asked to whittle down her findings. Even when Goldman executives admitted to wrongdoing in their briefings to the regulatory team, her colleagues pretended that they had not heard such things! Worse, she was asked to modify minutes of meetings so as not to implicate Goldman in any official record. Her willingness to stand up to her bosses cost her her job at the Fed though Fed officials publicly deny this.

It would have been easy to dismiss Segarra’s allegations as that of a disgruntled employee, or an individual case of one specific Fed team but for the fact that many of the issues she highlights were identified as key problem areas by a 2009 committee appointed by the New York Fed itself. The committee led by Columbia University professor of finance, David Beim,had first identified the culture of deference towards regulated entities as one of the key weaknesses of the organization.

The Beim report urged the Fed to change the way it regulated banks, which had so far been driven by the flawed assumption that markets will self-correct, and hence internal controls will be enough to discourage excessive risk taking in banks. Beim found that the regulatory lapses leading to the great financial crash of 2008 flowed more from cultural problems at the Fed than from the lack of technical expertise to deal with banking innovations. In large banks, Fed teams are located onsite and the physical proximity had led to a cosy relationship between Fed supervisors and the supervised. The revolving doors between the world of investment banks and the world of regulations only complicated the problem of regulatory capture.

The Segarra tapes and the Beim report perhaps offer one of the greatest challenges the US Fed has faced in its history. And at stake is not just the integrity of the US financial system, but the future of global finance itself.

The US Fed may well try to learn a few lessons from India in reshaping itself as a financial watchdog with teeth. The Reserve Bank of India (RBI) may have room for improvement when it comes to monitoring Indian banks but the culture of deference towards regulated entities is completely unimaginable in India. India’s ability to withstand the great financial crash without excessive damage to its economy is largely because of the efforts of former RBI governor Y.V. Reddy, who displayed great foresight and had enough intellectual clarity to question the dominant orthodoxy of the day.

At a time when regulators in the US were bending over backwards to please investment banks and financial policies were being tailored to suit those in trading rooms, Reddy showed little hesitation in slamming the brakes on an “overheated economy" despite stiff opposition from corporate lobbies and the finance ministry. Reddy resisted moves towards full capital convertibility, emphasized risks in over-financialization of the economy, and put curbs on bank lending to over-leveraged sectors much before macro prudential regulation was in vogue.

The Carmen Segarra episode clearly demonstrates that the onus of proving a financial innovation’s safety and desirability lies with the innovator. It is foolish to ask regulators to justify each and every intervention, especially during crises, in the name of accountability. The Financial Sector Legislative Reforms Commission recommendations on these issues need to be treated with great caution or else, India can land in the same soup the US finds itself in.

Is India better equipped to prevent regulatory capture? Tell us at views@livemint.com

Follow Mint Opinion on Twitter at https://twitter.com/Mint_Opinion

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Published: 30 Sep 2014, 05:17 PM IST
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