Do we want even policy decisions to be appealable, asks Raghuram Rajan

The Reserve Bank of India (RBI) Governor, Raghuram Rajan, on Tuesday, warned against excessive legal supervision on financial regulators as it would hamper policy-making and increase systemic risks.

“The broader point is that a lot of regulatory action stems from the regulator exercising sound judgment based on years of experience. In doing so, it fills in the gaps in laws, contracts, and even regulations. Not everything the regulator does can be proven in a court of law,” said Dr. Rajan while addressing State Bank of India Banking Conclave 2014, in Mumbai.

Talking on the suggestions made by the Financial Sector Legislative Reforms Committee (FSLRC), Dr. Rajan said that the creation of a Financial Sector Appellate Tribunal would hamper the policy decisions taken by the regulator. He asked, “How much checking and balancing is enough? Do we want even policy decisions to be appealable? Can legal oversight become excessive?”

The FSLRC had recommended several measures to reform the country’s financial sector. However, Dr. Rajan said that some of the recommendations seemed somewhat “schizophrenic” while still others ‘faddish and impressionistic” rather than based on deep analysis.

He stressed the need to guard against asking tribunals to make judgments. “They simply do not have the capability, experience, or information to make, and where precise evidence may be lacking. If we attempt to do this, we will undermine the very purpose of a regulator…….if set up, a tribunal will intervene more than necessary,” he said. Further, Dr. Rajan said that the encouragement to appeal could paralyse the system and create distortions, “as needed regulations are held up and participants exploit loopholes.”

“To the extent that private parties with their high-priced lawyers can check the regulator, that healthy respect (for the regulator) dissipates………the regulator could become a paper tiger, and lose its power of influencing good behaviour, even in areas that are not subject to judicial review,” Dr. Rajan added.

“So long as the Tribunal only questions administrative decisions such as the size and proportionality of penalties, I do not see a problem. But if it goes beyond, and starts entertaining questions about policy, the functioning of a regulator like the RBI, which has to constantly make judgments intended to minimise systemic risk, will be greatly impaired.”

He also warned that because of the tendency of any new organisation to overreach to justify its existence, one should be careful about tying the financial regulator with further judicial oversight.

He also criticised the suggestion to merge all regulation of trading under a new Unified Financial Agency, so that the Forward Markets Commission, as well as the bond regulation activities now undertaken by the RBI, would move under a new roof, as would the Securities and Exchange Board of India (SEBI).

Bond market

“My personal view is that moving the regulation of bond trading at this time would severely hamper the development of the government bond market, including the process of making bonds more liquid across the spectrum, a process which the RBI is engaged in,” said Dr. Rajan, adding, “this balkanisation would hamper regulatory uniformity, the supervision of credit growth, and the conduct of monetary policy.”

He said that there were places where the RBI could give up powers.

“If the government wants to manage its own debt, there is no reason for the RBI to stand in the way. I don’t believe the government suffers any less from conflicts of interest in debt management (unlike the views of the FSLRC), but the RBI could well carry out the government’s instructions without any loss in welfare. I imagine, however, that the government will depend on deputations from the RBI for a while for advice.”

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