In a US Supreme Court case in 1964 over obscenity, justice Potter Stewart realized he couldn’t formulate rules when trying to define pornography: “I know it when I see it,” he said. When trying to define financial stability, Reserve Bank of India (RBI) governor D. Subbarao last year realized the same: “It’s like pornography, you can’t define it, but when you see you know it.”
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Amorphous as it is, financial stability needs some discretion in tackling it. But who gets to exercise such discretion?
Illustration: Jayachandran / Mint
Finance minister Pranab Mukherjee wants to give the financial stability portfolio to a new Financial Stability and Development Council, whose setting up he announced in Friday’s Budget. As it now stands, RBI has this portfolio; in August it announced a financial stability unit expressly for this purpose. We don’t know what Mukherjee’s council will look like as yet, but regulators need to see if this change from the status quo is really an improvement.
Consider the vantage point the central bank is at for this job. First, financial stability involves, but isn’t restricted to, watching banks or markets for bonds, currencies and derivatives that “buy” or “sell” risk. It’s RBI that already regulates them.
Second, most of India’s recent instability has come from short-term capital inflows. It’s RBI that has the tools, such as its foreign exchange reserves, to manage them.
Third, broadly speaking, financial stability is linked to the monetary policy central banks traditionally set. Both price and financial stability involve the creation of money: Underneath economy-wide swings are swings in credit supply, which RBI already has its finger on.
Would it then not make sense to keep this portfolio with RBI? But in the long war for regulatory turf, others have suggested a “super regulator” to take RBI’s powers away. The Raghuram Rajan committee recommended an oversight agency in 2008; last year, Mint reported that the high-level coordination committee, that convenes all the top financial regulators may be given statutory teeth.
We aren’t suggesting such coordination or such a committee isn’t needed, but regulators should know the risks of formalizing one through legislation. Installing a super regulator should not mean diluting RBI’s authority. Nor should it mean adding bureaucracy—a fear Subbarao has expressed. Most of all, it should not mean trading away discretion in favour of rules, as legislators may be tempted to do.
After all, in 1973, the US Supreme Court itself tried to formulate rules for pornography. Thirty years on, the court has had to constantly reinterpret these rules because the previous standards failed.
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