Mumbai: A finance ministry discussion paper on the proposed Financial Stability and Development Council (FSDC) is set to invoke sharp reactions from the Reserve Bank of India (RBI) because the Indian central bank is of the opinion that the paper, prepared by the department of economic affairs of the ministry, has gone beyond its brief and is too critical of the existing regulatory regime. The Securities and Exchange Board of India (Sebi), too, has found the paper?focusing?on many things, beyond financial stability.
Apart from financial stability, financial literacy and financial inclusion, FSDC also plans to focus on next-generation financial sector reforms—an agenda that was not explicitly stated in the Union Budget that mooted the idea of the council—and many believe it will substantially dilute the role of the existing regulators.
The paper was circulated among financial sector regulators in end-May, before the promulgation of the ordinance by the President of India that sought to resolve the face-off between the stock market and insurance regulators. The 18 June ordinance—The Securities and Insurance Laws (Amendment and Validation) Ordinance, 2010—will empower the finance ministry to resolve all future regulatory disputes, including those involving RBI. Going by the ordinance, any of the four regulators—RBI, Sebi, Insurance Regulatory and Development Authority (Irda) and Pension Fund Regulatory and Development Authority—can make a reference to the joint committee headed by the finance minister, and the committee’s order will be “binding” on all regulators.
The combination of FSDC and the new arrangement, many say, will weaken RBI’s position substantially and dent its autonomous status (see Banker’s Trust on RBI governor’s letter to finance minister Pranab Mukherjee).
Mukherjee, in his February Budget speech, spoke about the establishment of FSDC “to strengthen and institutionalize the mechanism for maintaining financial stability”. He also said, “Without prejudice to the autonomy of regulators, this council would monitor macro prudential supervision of the economy, including the functioning of large financial conglomerates, and address inter-regulatory coordination issues. It will also focus on financial literacy and financial inclusion.”
The discussion paper emphasizes that FSDC “will not be a super-regulator” and that it will achieve “its mandate without undermining the autonomy of the regulators”.
Chaired by the finance minister, FSDC will have two committees under it—the financial sector regulatory coordination committee (FSRCC) and financial sector stability committee (FSSC). Modelled on the current high-level coordination committee on financial markets (HLCCFM), the regulatory committee will be headed by the RBI governor and will meet at least once in three months while the stability committee will be headed by the finance secretary. All regulatory heads will be on both the committees, and in addition to them, an RBI deputy governor will be a member of the stability committee.
Unlike the HLCCFM, FSDC will have a permanent secretariat to ensure smooth functioning of both the committees and the sub-committees that the regulatory coordination committee may have.
“A road map for next generation of financial sector reforms has been charted out by various government-appointed committees. This agenda needs to be driven in a coordinated manner to achieve results. There is a need for an institutional mechanism that can coordinate and oversee the reform and development agenda for the financial markets as a whole,” the paper said.
The 30-page discussion paper has questioned the efficacy of HLCCFM mechanism and blamed “developmental lethargy” for the slow progress of financial sector reforms.
According to the finance ministry’s paper, the record of discussions and decisions taken by HLCCFM are not in the public domain and, hence, they cannot be evaluated properly. Indeed the forum has discussed issues related to capital markets, regulations related to mutual funds and the controversial unit-linked insurance products (Ulips) among others, but “the actual facilitation by HLCCFM in these developments” is “not clear”. It also mentioned that the forum took two-three years to clear exchange-traded currency futures and failed to resolve the issues related to Ulips and foreign venture capital investments in real estates. “The forum has not achieved as much success with regard to inter-regulatory coordination as it potentially could have.”
While some of the regulators have been active in their “own ear-marked space”, HLCCFM has failed in piloting collective action, the paper said, citing the instance of repurchase or repo of corporate bonds. “… Even though the (R.H.) Patil committee recommended introduction of the repos in corporate bonds in 2005, it was not until March 2010 that repos in corporate bonds were allowed, that too with guidelines so stringent to retard vibrancy in this market,” it said. The paper blamed “rigid and stringent norms” for “lethargic development of the corporate bond market”, the lacklustre performance of interest rate derivatives and non-existence of credit default swaps.
According to the paper, policymakers need to focus on four critical areas—the bankruptcy process of large and complex financial institutions, capital requirements of various financial intermediaries in boom and bust, treating the entire financial system as one piece and not in silos governed by different regulators, and resolution of crises as and when they arise.
Referring to the 2001 crisis in the erstwhile Unit Trust of India, the country’s oldest mutual fund, and the liquidity crisis faced by the mutual fund industry in late 2008 after the collapse of the US investment bank Lehman Brothers Holdings Inc. led to an unprecedented credit crunch, the paper said, “In both these cases, (the) crisis management was led by the finance minister.” The key to crisis response, the paper said, was “the unique ability of a finance minister to secure acceptance of decisions across all government agencies in finance, and the potential use of public resources”.
When the mutual fund industry was reeling under the liquidity crisis, “the finance minister coordinated the analysis of the problem (involving mutual funds, banks, Sebi and RBI), and led the policy response where lines of credit of Rs20,000 crore were made available to mutual funds”.
Among other things, the finance ministry paper is also in favour of bringing in all financial instruments that are traded such as government as well as corporate bonds, currencies, equities, and commodity derivatives under one regulator and establishment of a national treasury management agency or a separate debt management office to manage the government’s annual borrowing programme. Currently, the government bond market as well as other derivatives which are traded over the counter are governed by RBI, while Sebi oversees the exchange-traded products. RBI also manages?the?government’s money raising programme, an annual exercise to bridge the country’s fiscal deficit.
“Separation of debt and monetary management is an accepted practice all over the world and is an essential part of the much needed next generation financial sector reforms in India,” the paper said.
The exact contours of FSDC will be framed after the regulators send their reactions to the paper to the finance ministry. It would appear that RBI has strong reservations about some of the proposals outlined in the paper, circulated among all regulators. The Indian central bank has been discussing this paper internally and is yet to send in its formal response to the ministry.