FSDC: listening to the winds of change

Relatively obscure until recently, the Financial Stability and Development Council (FSDC) came into the limelight with the Financial Sector Legislative Reforms Commission (FSLRC) report in March. Thereafter, concerns have emerged that FSLRC’s recommendations make FSDC a “super-regulator”, erode individual regulatory autonomy, and allow for political interference in what ought to be the fiefdom of regulators.

Unfortunately, many of these comments (most recently by the governor of the Reserve Bank of India, D. Subbarao) appear to stem from a lack of clarity on the recommendations.

Understanding this issue requires delving into a bit of history. Following Raghuram Rajan’s 2009 report on financial sector reforms, the existing but inconsequential high-level coordination committee on financial markets was loosely re-packaged as FSDC in 2010. Not being a statutory body, there are no records of FSDC’s successes or failures and there is minimal public information about its functioning. Crippled by an ill-defined mandate, inadequate staff, no powers and no accountability, FSDC as it exists today has failed to make an impact on the financial system, sinking instead into comfortable irrelevance.

FSLRC’s recommendations foray into the emerging field of systemic risk regulation (recognized after the global economic crisis of 2008-09 as being essential for financial reform). Under FSLRC’s recommendations, FSDC will be a statutory body with operational and financial autonomy and technically sophisticated staff. The minister of finance will chair its board with heads of financial regulatory agencies as its other members.

With sharp objectives, enumerated powers and comprehensive accountability, FSDC will perform five critical functions including designating systemically important financial institutions (SIFIs), inter-regulatory co-ordination and application of system-wide measures to target systemic risk. FSDC’s executive decisions will be appealable before the financial sector appellate tribunal envisioned by FSLRC.

Most commentators find the idea of FSDC as a statutory body worrying. Should FSDC have executive powers? they ask, effectively suggesting that yet another “committee” that merely discusses matters but takes no action is a preferable option.

In FSLRC’s world view, FSDC remains primarily an inter-regulatory co-coordinator. The draft Indian financial code, FSLRC’s recommendatory financial sector law, requires FSDC to regularly discuss matters of inter-regulatory concern, such as regulatory arbitrage. In this regard, FSDC has no executive powers of its own. The duty of micro-prudential regulation is kept away from FSDC, which cannot communicate directly with financial sector firms except in specific cases.

One such case is FSDC’s power to designate large, complex and inter-connected firms as SIFIs. Once designated a SIFI, a firm’s micro-prudential assessment will continue under the appropriate regulator, with no further role for FSDC. Similarly, FSDC will determine system-wide policy measures applicable to the entire financial system. Again, regulators will implement such measures individually, with no further FSDC involvement.

Empowering FSDC with SIFI-related functions is merely a happy coincidence of design. With all regulatory agencies on board, it is only fitting to task FSDC with system-wide functions. An individual regulator with specialized knowledge of, say, banking, but little else, will fail to understand interconnectedness in the entire financial system. This necessarily requires a cross-sectoral, systemic perspective that only FSDC will have.

Concerns regarding “invisible political interference” in FSDC’s functioning do not hold water either, given the stringent due process, and emphasis on rule of law running through FSLRC’s re-envisioning of regulatory behaviour. On the contrary, status quoist recommendations which prefer that FSDC remains a committee with no statutory backing, pave the paths for interference and peddling of influence.

Demonizing FSDC as a “super-regulator” that erodes regulatory autonomy is a misnomer of the highest order. FSLRC recognized that systemic risk regulation should be distinct from micro-prudential regulation, consumer protection or resolution of failing firms. In the absence of this separation, systemic risk regulation can easily descend into vague, over-reaching regulation. FSLRC consciously avoided this, through a precise articulation of what constitutes systemic risk oversight, avoiding Draconian control of regulatory powers, and emphasizing inter-regulatory co-ordination. Again, with all regulatory agencies on board, with an equal stake in systemic risk oversight, surely FSDC cannot separately indulge in regulatory land grab.

In this vein, FSLRC consciously chose not to define “financial stability”, a passive objective that could invite stagnant and protectionist policies. Instead, FSDC has the dynamic objective of “mitigating, monitoring and taking action to eliminate systemic risks” to “foster stability and resilience in the financial system”. That systemic risk oversight and financial stability are closely connected is well established globally, notably in the UK and the US, where agencies other than regulators combat systemic risk.

Tasking FSDC specifically with mitigating systemic risk ensures that the agency will be accountable if any systemic crises threaten our financial system. Such risks should necessarily be addressed by a combination of the political executive and regulators, as is done worldwide. India is in the enviable position of being able to learn from mistakes made elsewhere during the financial crisis, and adapt them to suit our system. There will always be those who seek to maintain the status quo in the face of pressing change. To them we say, respectfully, we disagree.

Sowmya Rao and Sumathi Chandrashekaran are legal consultants with the National Institute of Public Finance and Policy. They were members of the FSLRC research team.