This blog post is in continuation of the previous blog posts on Raghuram Rajan's report titled "A Hundred Small Steps" written in 2008 whilst he was with the Planning Commission of India.
The second section of the report focuses on "Creating A Growth Friendly Regulatory Environment."
Proposal 20: "Rewrite financial sector regulation, with only clear objectives and regulatory principles outlined. However, such legislation would have to be drafted carefully, as Indian courts are
not likely to look upon excessive delegation favourably (the Supreme Court of India has held that the ‘essential legislative function’ cannot be delegated and a statutory delegate cannot be given an unguided or un-canalized power). What should be left to the regulator is the ancillary function of providing the details."
--There have been a lot of developments in this field since the Financial Crisis of 2008. USA implemented the Dodd-Frank Regulations wherein banks were forbidden from trading with their own money to reduce systemic risks. This has led to reduced economic activity in the financial space but considering the impact of the crisis, this might be the right way to go.
Another important regulation in this area is the Glass-Steagall Act in USA from 1992. This made a clear demarcation (fire wall) between retail banking and investment banking and did not allow the two to mix. This restriction was lifted in an amendment in 1999, just before the dot com bubble burst.
The Canadian banking regulations are also noteworthy since not a single Canadian Bank failed during this crisis and there was no government intervention needed.
Even the Indian banks were pretty resilient at the time of the crisis and the banking system received significant recognition for its resilience.
Proposal 21: Parliament, through the Finance Ministry, and based on expert opinion as well as the principles enshrined in legislation, should set a specific remit for each regulator every five years. Every year, each regulator should report to a standing committee (possibly the Standing Committee on Finance), explaining in its annual report the progress it has made on meeting the remit. The interactions should be made public. In addition, to ensure there are more direct checks on the regulator in a system that is less rule-bound, the Committee recommends Proposal 22.
--This would be like oversight of the regulators. I don't think such a body exists in most countries. At the highest level, regulatory authorities are accountable to the Prime Minister (President) of the country and serve at his / her discretion. They should be allowed to be independent.
Proposal 22: Regulatory actions should be subject to appeal to the Financial Sector Appellate Tribunal, which will be set up along the lines of, and subsume, the Securities Appellate Tribunal.
I don't think the top regulators in USA are accountable to any one other than the President, be it the Consumer Financial Protection Bureau or the FDIC. No doubt, they are subject to Parliamentary investigations and probes if their actions are found to conflict with the interests of the businesses to an unacceptable level.
Proposal 23: Supervision of all deposit taking institutions must come under the RBI. Situations where responsibility is shared, such as with the State Registrar of Cooperative Societies, should gradually cease. The RBI will have to increase supervisory capacity to take on this task. The Committee recognizes this involves constitutional issues but nevertheless recommends a thorough overhaul of the system of shared responsibility.
I think the regulation of financial institutions should be left to the watchdogs like the Securities and Exchange Board of India. I don't see a reason why this power should fall with the RBI.
Proposal 24: The Ministry of Corporate Affairs (MCA) should review accounts of unlisted companies, while SEBI should review accounts of listed companies.
Whilst the publicly listed companies are under the review of SEBI at present, the unlisted companies are not regulated or supervised. It might be a good idea to have unlisted public companies to be under review of a regulatory agency, but their identification would be very difficult since they are unlisted.
Proposal 25: A Financial Sector Oversight Agency (FSOA) should be set up by statute. The FSOA’s focus will be both macro-prudential as well as supervisory; the FSOA will develop periodic assessments of macroeconomic risks, risk concentrations, as well as risk exposures in the economy; it will monitor the functioning of large, systemically important, financial conglomerates; anticipating potential risks, it will initiate balanced supervisory action by the concerned regulators to address those risks; it will address and defuse inter-regulatory conflicts.
This would be a role more suited for the RBI rather than the that of a watchdog or regulator.
Proposal 26: The Committee recommends setting up a Working Group on Financial Sector Reforms with the Finance Minister as the Chairman. The main focus of this working group would be to shepherd financial sector reforms.
Special Focus Groups are a good means to deal with complex legislative issues and there should be such groups for almost all sectors. They should comprise of a eminent industrialists, academics and a few elected politicians from the Lok Sabha and Rajya Sabha.
Proposal 27: Set up an Office of the Financial Ombudsman (OFO), incorporating all such offices in existing regulators, to serve as an interface between the household and industry.
The subject of ombudsman has been raised by a lot of parties in recent times, prominent amongst them being AAP. This would be a good idea as it would set up a feedback channel from the industry participants to the focus groups and other legislative agencies.
Proposal 28: The Committee recommends strengthening the capacity of the Deposit Insurance and Credit Guarantee Corporation (DICGC) to both monitor risk and resolve a failing bank, instilling a more explicit system of prompt corrective action (see Proposal 3), and making deposit insurance premia more risk-based.
The FDIC insures all deposits of constituent banks and imposes a certain set of regulations in return. We could try a similar model. Also, bankruptcy laws are in the process of being consolidated with the Madras Court Tribunal (MCLT) and other central bankruptcy regulations having overlapping authorities. A consolidated bankruptcy law such as the Chapter 11 in USA is needed in India.
In the next post, I will discuss the next section on "Creating Robust Infrastructure for Credit" from the same report.
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