The plan of the Financial Sector Legislative Reforms Commission (FSLRC) to reshape India’s financial markets, as outlined in a 1 October approach paper has several attractive features, which mark a clear break from the past. Yet, the plan can succeed only if the commission offers greater clarity on contentious issues such as those relating to regulatory functions, and provides a transparent summary of the costs, risks and benefits associated with its proposals.
FSLRC was set up in March 2011 to comprehensively re-examine financial law and the regulatory structure in India. A key attraction of the FSLRC plan is the proposal to set up a financial redressal agency to protect consumer rights. The commission has proposed a single regulator for all financial products other than banking that will replace four existing regulators and also take over regulations relating to bonds and currency markets that are currently under the joint purview of the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI). It has recommended trimming down RBI’s functions, suggesting an independent debt management office take over the responsibility for this.
The commission’s proposal on overhauling the regulatory architecture leaves some practical questions unanswered. The approach paper lays down a detailed rule-making process to ensure accountability of regulators, but does not spell out the mechanisms to ensure autonomy.
The key malaise of the Indian financial system is lack of autonomy for regulators rather than lack of accountability. India’s record in creating independent financial regulators so far simply does not inspire much confidence. The approach paper has high praise for the two-decade-old track record of capital market regulator Sebi. But Sebi’s recent history is far from glorious and the finance ministry’s rising influence over it is well-documented (read Sebi’s autonomy is under attack).
Of India’s financial regulators, RBI enjoys relatively greater autonomy because of three key differentiating factors: greater control over finances, a well-paid team of in-house technocrats, and a convention allowing independence in central banking. Autonomy allowed RBI under former governor Y.V. Reddy to take counter-cyclical measures ahead of the global financial crisis in 2008 despite being under pressure from the Centre not to do so. Reddy’s interventions saved the economy from major damage during the crisis. Although RBI has lost sheen since then, it still remains among the better managed central banks in the developing world.
The onus, therefore, will be on FSLRC to demonstrate that reducing the role of RBI in the economy will lead to considerable benefits, and the independent debt management office it envisages will be able to withstand pulls and pressures of the finance ministry. The same argument holds for its proposal on creating a new unified financial regulator.
The approach paper is a good first step, but given the far-reaching and possibly irreversible effects of FSLRC’s proposals, outlining the expected outcomes transparently will ease the path to implementation.
To cite one example, the approach paper talks about a bond-currency-derivative nexus that can be developed under a unified regulator. In the aftermath of the financial crisis, the conventional wisdom on both the necessity and desirability of such a nexus stands challenged. Hence, rather than assume that the gains of such a nexus are self-evident, it will serve FSLRC’s cause to lay down the quantifiable gains as well as the risks that arise from developing such a nexus, and to provide examples of what such a nexus has achieved in the growth of the real sector in comparable developing economies.
One of FSLRC’s most useful recommendations is a rule-making process for framing regulations, which entails that regulators precisely identify the problem they seek to correct, and state the costs and benefits of the intervention they propose to solve the problem. FSRLC can gain enormous credibility and acceptance if it adheres to the same standards that it expects regulators to follow while designing proposals.