The Reserve Bank of India (RBI), prior to its credit policy announcements, holds meetings with bankers. It also has a panel of advisors who meet. Now imagine these scenarios:
• RBI starts another set of regular meetings with finance secretaries of states, or their designated representatives. In those meetings, the finance secretaries vote on things like whether the repo rate should be reduced by 25 basis points or not. One basis point is one-hundredth of a percentage point.
• RBI expands the scope of such meetings to include discussions on who should be given banking licences.
Unrealistic? Not at all. With individual states getting involved even in foreign policy matters, which, strictly speaking, are outside their constitutional ambit, can finance be far behind? Or rather, should finance be far behind? The undercurrent of tension involving the yet-to-be-passed Microfinance Bill 2012 exemplifies this: the Bill is effectively set to make RBI the regulator for microfinance and weaken the states’ hold over the sector.
Finance is not an exclusively an Union list item. Micro- or ground-level finance has been accorded state responsibility, whereas broader areas are vested with the Centre, as per the general theme of Constitutional division of powers (such as, policing, or civil defence, is a state subject whereas national, or military defence, a central subject). So, for instance, chit funds come under the purview of states but commercial banking falls under central jurisdiction, subordinated to the regulatory authority RBI. There is one more area where states play a vital but less recognised role, foreclosure of assets on borrower default, as local courts and police are involved in this. But these have been a result of expediency rather than a well-thought out strategy.
Why have states been indifferent to asking for a more holistic stake in financial policy matters? Interest rates directly impinge on their cost of market borrowings, and spread of banking and insurance (financial inclusion) impacts them in a big way. The only plausible reason is that the so-called finance function in states is structured only to extract maximum concessions from the Centre in the form of assistance through transfers and grants. They concentrate more on what they can achieve right now rather than on policy matters that will take at least a few years to show results (time inconsistency problem).
But the decibel level of states is increasing as they stand more on their own feet and are able to attract investors separately. Thus, it is natural that they may also like to have a say in policy matters in the financial sector. And increasingly, it will be harder for the Centre to throw the rule book called the Constitution at them.
The obvious justification for states to be given more say is that the character of finance has changed; it is a lot more democratised and is no longer the prerogative of the elite. Also, there is a limit to how much the Central institutions can regulate. Many questionable financial companies that surface from time to time (ponzi schemes) operate largely at the state level. They vanish and resurface in a mutated form with the kind of rapidity that makes it impossible for Central agencies to handle them. Though states do have some powers over these, there are quite a few jurisdictional overlaps. States also ought to be consulted in a structured fashion when new laws in these areas are being framed.
But this should not degenerate into a privilege unaccompanied by responsibility. It will necessitate a significant amount of capacity building at the state level, involving educating legislators and bureaucrats, and enhancing the quality of policy consultants in states. The Central machinery in financial policy is very developed, with capabilities of public institutions such as RBI and Securities and Exchange Board of India in line with those in advanced nations. It should be assisted and enriched, not destroyed by mindless interference by individual states that intend to further their narrow agendas.
The Central institutions are acutely aware of this eventuality, and in particular, RBI has been very resentful of the way states have handled certain financial matters that have been entrusted to them, like cooperative banks which was a good experiment soured by the ineptitude of states. It is but natural that they will resist the larger involvement of states unless they demonstrate their seriousness, and of course, preparedness.
It will perhaps be meaningful to entrust the fledgling Financial Sector Development Council with the responsibility of involving states in financial policy matters, since it fits very well within its primary remit of coordination across regulators (states are also regulators). Then there will be an institutional structure to it. But we better recognize that there is no choice; else we run the risk of another source of centre-state conflict that we can ill-afford.
Dipankar Choudhury has been a 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.