Even aside from the expertise factor, the case in favour of regulatory autonomy is quite obvious. In fact, the key reason propounded by scholars and strong advocates of independence such as the IMF and the BIS—the time-inconsistency problem—is very acute in India. It means that in order to impart a sense of permanence and stability, regulation has to be distanced from politicians who can bend it to suit the current electoral cycle (this is globally accepted thinking, lest you feel it is tailored to India!). Time inconsistency of a government vis-a-vis a regulator is more problematic in case of financial regulation whose effects necessarily manifest with a lag.
What makes it more pertinent for India is that pressure groups are multifarious and any government with lion’s share of the regulatory burden will find it impossible to discharge the function effectively. One of the many examples was the threat of withdrawal of support by a coalition partner if a state cooperative bank was investigated; fortunately, since the government could point out that it was an independent regulator’s decision and not its own, a showdown was averted.
What underscores the importance of independence further is that while promoting competition and consumer interest is the common goal of all regulators, financial sector regulators have to additionally ensure financial stability. This requires regular, intensive supervision of regulated entities and corresponding action, if need be, which is not effective without adequate autonomy.
In India, like many developing markets, the government itself is a major owner of and player in the financial markets. Mandated regulatory autonomy, and not just a de facto one, is a clean way of ring-fencing government and regulators to explicitly avoid this rather piquant conflict of interest (i.e. regulator, authorized by the government, regulating government-owned entities). As such, large budget deficits are smartly impinging on central bank independence without obvious conflict. In any case, a central bank cannot check a government’s temptation to overspend for short-term gains, upsetting monetary policy. It is imperative to rein in the short-sightedness so universally shown by governments over the last five years.
Examples abound in other areas. Sebi is forced to have two different free-float rules for private companies and PSUs. It has still not forgotten how the erstwhile Unit-64, a government mutual fund, used to thumb its nose at regulation. Insurance Regulatory and Development Authority (Irda) does not even come to know when the government raises the single-company investment limit for the LIC. All these are instances of unhealthy meddling in the financial markets, inimical to its development.
Indeed, that is why a regulated industry is always on its toes when there is an independent regulator. For example, if banks know that backdoor political negotiations will not lead to bailouts, they will behave more responsibly. Ceteris paribus, an autonomous regulator is more successful in keeping out moral hazard.
The light-touch regulatory approach of the highly independent developed markets financial regulators came in for heavy criticism for having fostered regulatory capture after the 2008 crisis. Paradoxically though, it is probably less autonomy that could lead to capture-like cases in India if not full-blown expensive captures.
Indian regulators have been good averting capture, but not always. Irda’s strong-fisted dealing with the insurance industry from 2010 is well-known, ignoring the exhortation to follow a milder approach. Sometime in 2008 when the telecom industry told Trai that it will go bankrupt if a certain measure was adopted, the regulator bluntly said that an industry does not go bankrupt, a company does. However, a government is easier to manipulate than a regulator. Hence a not-so-independent RBI is forced to look the other way, and occasionally even accord forbearance to, bank lending to infrastructure companies, Kingfisher, Dabhol and Air India. While Sebi showed remarkable independence in reducing distributor commissions, it was aggressive lobbying with the government by fund houses and distributors that finally forced its hand at reversing some of the stringent regulations. And of course there is the Sahara fracas.
As Gurcharan Das once remarked, blaming economic reforms for corruption is barking up the wrong tree; it is actually incomplete reforms (e.g. in land and spectrum) that has encouraged corruption. Likewise, the fear of an irresponsible “fourth estate” if autonomy is increased is irrational. After all, in a democratic setup, the ‘goal independence’ always rests with the government, and it is only the ‘instrument independence’ that is given to the regulator, with possibly a sprinkling of policymaking objectives.
Adequately delegated and accountable regulatory autonomy is the answer. Independence in its true spirit, even if not de jure, is important, because as the Brazilian experience shows (Prado, 2005), institutional guarantees too sometimes fail in ensuring autonomy. The umbilical cord between regulators and the government often results in the disconnect between formal and real independence, even in developed nations (Gilardi & Maggeti, 2010).
Dipankar Choudhury has been a senior research analyst on financial services as well as other sectors at various investment banks, and is currently an independent consultant focusing on banks and financial services.