Mumbai: The Reserve Bank of India, or RBI, has made a strong pitch for holding on to its turf of being the sole regulator for the financial sector. This, according to the Indian central bank, is essential to ensure financial stability.
Admitting that the global financial meltdown has led to a debate on the regulatory structure best suited to safeguard financial stability, RBI’s Report on Trend and Progress of Banking in India, an annual publication that provides a detailed account of policy developments and performance of commercial lenders in the country, said: “...The responsibility for financial stability cannot be fragmented across several regulators; it has to rest unambiguously with a single regulator, and that single regulator optimally is the central bank.”
It also said, “There is need for coordination across regulators on a regular basis and for developing a protocol for responding to a crisis situation”.
Turf war: The RBI building in New Delhi. The central bank has made clear that it is not ready to concede ground to Sebi. Harikrishna Katragadda / Mint
The RBI report said that the present arrangement of regulating over-the-counter (OTC) derivatives products, or products not traded on exchanges, is well established as only those derivatives where one party to the transaction is an RBI-regulated entity, have legal validity.
By saying this, the Indian central bank has made it clear that it is not ready to concede ground to the capital market regulator Securities and Exchange Board of India or Sebi and intensified the turf war that RBI governor D. Subbarao hinted at in September by coming down heavily on two influential reports that suggested transfer of power to regulate all financial instruments to Sebi.
The exchange-traded products are regulated by the Sebi anyway and hence, “...unlike many countries, India has established procedures for regulation of OTC derivatives”, the RBI report said.
Both the Percy Mistry committee report on making Mumbai an international financial centre and Raghuram Rajan panel report on financial sector reforms had suggested Sebi as the sole regulator of derivatives transactions.
While there are several models where the central bank’s role is limited as a pure monetary authority with bank regulation and supervision vested with another agency, “post-crisis, the emerging view is that the crisis was caused, at least in part, by the lack of coordination and communication between the separate bodies and that it is optimal, in the interest of financial stability, to entrust the function of regulation of banks and non-banks also to central banks”, RBI report said.
“It is worth noting that some advanced economies where regulation and supervision are with an agency other than the central bank are themselves revisiting their regulatory structures and contemplating some unification”, it added, referring to the latest debate in the UK where lobbying for dismantling the Financial Services Authority, or FSA, is getting stronger by the day.
FSA regulates the financial sector while Bank of England is the monetary authority in the UK.
The report reiterated the governor’s statement last month that unlike equity prices, interest rates and exchange rate are key macroeconomic variables with implications for monetary policy and overall macroeconomic stability.
By regulating banks, which dominate the interest and exchange rate markets, RBI is in a position to take advance action to maintain financial stability at the systemic level.
“This is an arrangement that has stood the test of time, has protected financial stability even in the face of some severe onslaughts,” and hence “it may be desirable to continue with the present arrangement in the interest of pre serving financial stability.”
The report also does not endorse the stance that the high level coordination committee on financial markets—that consists of many regulators and the finance secretary— should have a formal structure. The current structure, according to the central bank, enables free exchange of positions, views and opinions, and a formal structure to the forum will make it excessively bureaucratic and “detract from its other value adding features”.
The report also touched upon the “tension between fiscal and monetary policies” and said it “could potentially militate against financial stability”. It said high fiscal deficits could make a central bank’s job of maintaining price stability difficult, which is a “necessary condition” for financial stability.
Since September 2008, after the collapse of US investment bank Lehman Brothers Holdings Inc, RBI has initiated various measures to make liquidity available in the system and bring down interest rates. It has brought down its policy rate from 9% to 3.25% now and commercial banks have been parking about Rs1 trillion worth of excess funds with RBI daily. Still, the loan rates of banks have not come down substantially as the government needs to borrow Rs4.51 trillion from the market to bridge a 6.8% fiscal deficit. In that sense, the impact of RBI’s monetary policy has been nullified by the fiscal constraint of the government.
The RBI report also said that managing trade-off between financial stability and growth is a challenge.
The central bank has traditionally been using a variety of prudential measures such as specifying exposure norms and pre-emptive tightening of risk weights and provisioning requirements to protect over-heating of the financial system.
“But these measures are not always costless. For instance, tightening of risk weights tempers the flow of credit to certain sectors, but excessive, premature or unnecessary tightening could blunt growth.”