Varied kinds of banking and finance problems seem to be spreading around the world. The outgoing New York Federal Reserve president William Dudley recently spoke about the London Inter-bank Offered Rate (Libor) fraud, the incoming president spoke about the need to improve banking culture, Bank of Italy officials are grappling with non-performing assets problems in their economy and, of course, India’s own central bank governor Urjit Patel has highlighted that the Reserve Bank of India (RBI) needs more powers to regulate ailing public sector banks.

Amid all this chaos, a speech called “Come With Me To The FPC" by Anil Kashyap—professor at the University of Chicago and a member of Bank of England’s Financial Policy Committee (FPC)—is relevant. The title of the speech is picked up from a 1998 speech by Lawrence Meyer, who as a Federal Reserve governor, said: “Come with me to the FOMC (Federal Open Market Committee)". Kashyap’s speech, just like the earlier FOMC one, gives a preview of what exactly the FPC is and how its members are trying to create a difference in UK’s financial policy.

So what is the FPC? After the 2008 crisis, one major loophole that emerged was that financial regulation just looked at the risk of individual firms (microprudential) but failed to look at risks emerging collectively (macroprudential). So, individually, the banks might be giving a low quantum of housing loans, but collectively it could make a large number. If the housing sector collapses, the total risks in the banking system would lead to serious financial distress, as was seen in several countries in the aftermath of 2008. Then there are cross-linkages with other financial sub-sectors such as banking, mutual funds, and insurance, leading to the entire sector becoming adversely affected.

In the UK, they decided to fix this loophole by instituting an FPC whose mandate was to look at the financial sector in a holistic manner and assess macroprudential risks. It is a 12-member committee with diverse representation from the Bank of England, Financial Conduct Authority, private sector and academia. The committee meets four times a year and releases its flagship financial stability report twice in those meetings. Just like India’s monetary policy committee sets interest rates, the FPC sets the countercyclical capital buffer rate, which basically tweaks the capital requirements for banks. If the FPC sees that risks could be high in the future, it asks banks to increase its capital ratio. Apart from this, it also analyses debt of households and firms and takes suitable measures.

Just a brief such as this will convince most people (read, Keynesians) that our country should also have such a body. Kashyap also notes in his speech: “Put this way it seems like no one could oppose this goal. In fact, I guess most people would say how could someone not have always been responsible for this objective? Remarkably, before the crisis such committees were missing in all the major countries in the world. And even to the extent that such bodies have been set up today, they still differ significantly in their mandates, personnel and powers."

Interestingly, India already has some institutional arrangements that require reporting on the financial sector. It started with statistical tables related to banks in India, which were started by the British to capture information on failing banks in the country. Next was the Banking Regulation Act (1949) mandating that the RBI release an annual report, “Trend And Progress Of Banking In India". The RBI also started the “Report On Currency And Finance", which was not mandatory but nevertheless gave us an overview of developments in the financial sector. It also released a financial market outlook in its annual reports and Macroeconomic and Monetary Developments (discontinued in September 2014). In its monetary policy decisions, the RBI also releases a document on regulation developments, which contains proposed changes in banking regulations.

Post the 2008 crisis, further measures were taken. The government established a financial stability and development council (FSDC) to bring greater coordination among financial market regulators. The FSDC replaced the earlier high-level coordination committee on financial markets, which was more of an informal body. The FSDC was chaired by the Union finance minister, which led to friction between the ministry and regulators—but assurances from the former bridged the differences. In 2010, the RBI also started releasing its biannual “Financial Stability Report" (FSR), which has become the flagship report. From December 2014 onwards, RBI merged the “Trend And Progress Report" with the FSR.

Given this quick panoramic view, should we continue with the status quo or establish a new FPC? The former will not work given how financial markets and activities have become increasingly interconnected. It is only a matter of time before problems in Indian financial markets start to resemble those in the West. In fact, as Andy Mukherjee of Bloomberg recently pointed out, India is poised to have its own sub-prime moment in the near future. The FSDC, despite being a decent initiative, lacks diversity of opinions and is more of a bureaucratic exercise. The minutes of FSDC meetings are released via a press release but barely contain any information. The several RBI reports are scattered, though efforts have been made to streamline them.

The alternative is to appoint a new FPC and reallocate the finance-related decisions, responsibilities and publications to it. The MPC can focus on macroeconomics and interest rates. This might invite criticism that one crucial lesson of the 2008 crisis was the integration of macroeconomics and finance, and going down this road would mean separating the two. But this is not the case here as the FPC and MPC would have common members like the RBI governor and deputy governors. It’s just that the FPC would have more specialists in the domain of finance just as the MPC has in macroeconomics and monetary economics. Finance has become heavily specialized and interconnected in recent years and warrants attention from specialists.

We may not be able to prevent a future financial crisis but can at least try mitigating its damaging effects. FPC could be one of the ways to achieve this.

Amol Agrawal teaches at Ahmedabad University and blogs at mostlyeconomics.wordpress.com. Comments are welcome at theirview@livemint.com.

Close