When a country moves from a central command economy to a market-based one, the key to the transition is a well-thought-out regulatory approach. India has hurtled forth pellmell in brief bursts of manic energy and then years of lethargy on the road to a market economy. The on-again-off-again approach has not allowed a structured thought-through regulatory system to get put in place. The damage this approach has done shows up in India’s current asset mix. Households have continued to prefer, and have increased their share of, gold and real estate for conversion of savings to investment. That left their share of financial products at just 10% of gross domestic product (GDP) in 2010-11, down from almost 13% in the year before. The financial sector is the key resource allocator moves money from savers to investment destinations. How easily and safely and at what cost it does that determines its efficacy.

India has clunky systems and a regulatory framework that is out of tune with the new needs of an integrated global financial system, where even a tiny exporter may need a hedge in several different currencies or a retail investor may use derivatives to hedge a stock portfolio. The Indian financial sector rule book is not just fragmented across overlapping turfs but is, in many cases, more than 50 years old. The Reserve Bank of India Act dates back to 1934 and the Insurance Act to 1938. Worse, it has been written separately for each subsequent regulator piecemeal, oftentimes keeping political outcomes in mind – nothing else would explain the location of a regulator in Hyderabad (where the insurance regulator is based). The result has been regulatory arbitrage and largescale harm to consumer confidence in the financial products market.

The aim was to make the rules contemporary and construct a set of financial laws to give the Indian financial sector a strong legal foundation over the next 30 years. The approach paper uploaded on Monday gives a roadmap to this regime as the commission views it.

The approach paper is a very broad-strokes concept note that lays out the thought behind future laws. The paper uses the “common-law" approach that allows for a principle-based approach where laws will define broad principles that will not change with technology or innovation. The commission sees individual regulators writing subordinated legislation that could be rules or principle based, depending on the regulatory aim. These laws will be across eight areas — consumer protection, micro-prudential regulation, resolution of failing financial firms, capital controls, systemic risk, development, monetary policy and debt management.

Two things that jump out at the first reading are the deep consumer focus of the commission and the plan to move to a seven-agency financial sector regulatory system. First, the paper correctly lists consumer protection as the first objective of any financial regulation and looks at a two-pronged strategy that works on both prevention and cure.

Prevention will put the burden of consumer protection on the provider of financial products and services, a definite improvement from the current ‘buyer beware’ model. Cure will look at setting up a Financial Redressal Agency (FRA) as a single stop for all consumer complaints in the financial sector with a consumer-facing front in every district.

Two, the paper seeks to put in place the afore-mentioned seven agencies in the regulatory architecture — a central bank with a focus on monetary policy and one that enforces consumer protection and micro-prudential law in banking and payments; a unified financial regulatory system that enforces consumer protection law and micro-prudential law in all finance other than banking; a resolution agency; a unified appellate body; a consumer complaints agency; the Financial Redressal Agency; the Financial Stability and Development Council (FSDC); and an independent debt management office.

This would mean that the current multiple non-banking financial sector regulators will collapse into one. The capital market, insurance, pension, and forward markets regulators will all be merged into the unified financial agency, if this approach paper becomes reality.

This is just the approach paper. Given the radical recommendations, expect a massive pushback.

Disclosure: The writer worked on the Swarup committee in 2009 as advisor and peer reviewed the consumer protection chapter of the approach paper.

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