Despite opposition from influential voices (See for example A. Vaidyanathan, “Undermining the regulatory system”, The Hindu, July 20, 2010), the government went ahead with the introduction and subsequent passage in the Lok Sabha of the Securities and Insurance Laws (Amendment and Validation) Bill, 2010 (SILB 2010). That bill which seeks to replace an Ordinance issued in June 2010 to deal with a jurisdictional dispute over regulation of Unit-linked Life Insurance Policies, provides for a Joint Committee headed by the Finance Minister (with the Finance Secretary as convenor) to resolve similar disputes regarding regulatory jurisdiction over hybrid products among financial regulators — the RBI, SEBI, the IRDA and the PFRDA. When such disputes do arise the decisions of this committee convened by the Finance Ministry is to be overriding.
It may be argued that since this relates only to hybrid products and concerns the resolution of jurisdictional disputes, the Bill, which is still to go through the upper house, has little significance. But there are a number of reasons why there could be cause for concern. To start with, since financial liberalisation has blurred the walls separating different financial markets and the activities of different kinds of institutions (such as banks, insurance agencies and securities firms), hybrid products are likely to be the norm rather than the exception. This increases the possibility of jurisdictional conflict, which may remain dormant for a time but can erupt in certain circumstances, especially if such products begin to be designed with regulatory arbitrage in mind. Firms wanting to avoid more stringent regulation in some markets may move into others and design products to continue with their earlier activity in “hybrid” form with lesser regulation. This was possibly the SEBI’s perception when it sought to regulate ULIPs. Hence, regulatory conflict is likely to resurface, necessitating a mechanism to deal with it.
Thus, it is not whether such a mechanism is necessary that is at issue, but whether the mechanism specified by the Bill in question is the best. It definitely is not, since it increases the power of the Ministry of Finance, which is already all too powerful. The world over, Finance Ministries, which control the purse strings of nations, constantly try and encroach into policy-making in a wide range of areas outside their immediate ambit. Nowhere is this more visible than in India, where the annual budget speech has become the instrument to test and push through major economic policy changes, not all of which have to do with the fisc. To boot, with much of banking in the public sector, and the Finance Ministry having a role in financing equity investments in and deciding the chiefs of public sector banks, the reach of the Ministry extends to the core of the financial sector. The Reserve Bank of India (RBI) may be the principal banking regulator, but it is the Finance Ministry that determines the stance of the banking industry.
Given this context, it would be wrong to further increase the Ministry’s powers, by making it the nodal agency for a mechanism to resolve jurisdictional disputes. Since the policies of financial liberalisation that lead to the creation of opaque, hybrid products are substantially shaped by the Finance Ministry, having it as the ombudsman when regulatory conflicts arise around these products is to make an agency to be regulated the regulator.
That having been said the issue of dealing with conflicts generated by hybrid products needs resolution. The tone and tenor of many who have expressed their opposition to SILB 2010 is that it is the Reserve Bank of India that should be the final arbiter on all regulatory questions. Besides the fact that the central bank is unlikely to have the expertise to regulate an increasingly diversified financial sector, there is a basic difficulty with this perspective. This argument in favour of granting final power to the RBI is part of an overall perception that every country needs an “independent” central bank run by experienced professionals who are pure technocrats, which monitors others, but must itself be above monitoring. However, if there is one strong message which has come out of the recent crisis, it is that this perception is wrong. The Federal Reserve in the US which had the responsibility for macro-prudential regulation and was seen as an independent agency run by strong leaders, including iconic chairpersons, was found wanting in that, despite warnings of the danger involved, it had kept pumping liquidity into the system and allowed the proliferation and accumulation of risky credit assets and derivatives based on them. It wrongly presumed that while inflation in the prices of goods and services was a sign of overheating that called for pulling back the monetary lever, an inflation in asset prices was not. This view was undoubtedly influenced by the fact that the wealth illusion that asset price inflation created, sustained the debt-financed spending that delivered growth. Volcker and Greenspan have in different ways admitted that this was a big mistake. The message is clear. Central banks are also run by humans (mostly male), and they like all humans are fallible.
This sets some ground rules for the way the system should evolve. To start with, it does not pay to make the system too difficult to regulate. The tendency to create opaque, hybrid products that are risky and generate jurisdictional disputes over regulation needs correcting in the first place. Financial products must be simple and safe, financial markets should as far as possible be kept separate and financial institutions should be focused on specific markets. This makes the system transparent and regulation much simpler. Second, there have to be a multiplicity of regulatory bodies with the appropriate skills and a Committee (that already exists) through which they coordinate their activities, to the extent that is necessary. That committee cannot be a creation and a handmaiden of the Ministry of Finance, it must be a forum of equals. And finally, there must be a monitor on behalf of “the public”, which consists of some investors in financial instruments and many potential victims of financial failure. This monitor can only be a parliamentary committee. There are Standing Committees for the purpose, but they are inadequately informed and not appropriately mandated. The committees or versions of them need to be supported with a parliamentary research service with the right to access information that has the expertise and is tasked with the job of monitoring financial firms and markets so as to ensure that financial policies are in the public interest, that markets are not hotbeds of speculation and that regulators do their job. Only with the backing of such a service can parliamentarians serve as the monitors they must be. Stated simply, parliament cannot be just a forum where decisions made by the Finance Ministry are pushed through with a voice vote. Hence this bill which makes it just such a forum, should not go through the Rajya Sabha before there is more informed debate on the issue.