In his budget speech, Finance Minister Pranab Mukherjee outlined a proposal to set up an apex level Financial Stability and Development Council. Although many more details will have to be worked out, the Council will co-ordinate the activities of the existing financial sector regulators, including the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority.
By setting up the Council, the government “hopes to strengthen and institutionalise the mechanism for maintaining financial stability.''
Financial literacy
The new body will function in a way that the autonomy of the regulators is not affected in any way.
The Council would monitor macro prudential supervision of the economy, including the functioning of large conglomerates, and address inter-regulatory co-ordination issues.
It will also focus on financial literacy and financial inclusion. The announcement has become one of the most debated points of the budget. At present, there is the High Level Coordination Committee (HLCC) on capital markets, supplemented by operational co-ordination between regulators.
The HLCC has, however, been found to be deficient, notably in preventing turf wars among regulators. There has been, for instance, a lack of clarity as to which regulator, the RBI or SEBI, will regulate the recently introduced interest rate futures that are traded on the National Stock Exchange.
In fact, regulation of the debt market has suffered. Banks are the principal players in the debt segment and they are regulated by the RBI. SEBI, on the other hand, has a mandate to regulate financial markets.
Similar confusion over the demarcation of regulatory roles between the IRDA and SEBI exists over the popular unit linked insurance plans (ULIPs).
Over time as disintermediation of the financial sector gathers steam, there would be many more hybrid instruments that combine features of banking, insurance and the capital market.
So having an apex body to supervise those does make sense. But the difficulty is in creating and empowering a new body which not only acts as an umpire but does not also trample upon the autonomy of the individual regulator.
Also co-ordinating the operational aspects of the different regulators is, however, only one of the objectives in setting up a new Council.
The government would also like it to monitor prudential supervision of the economy, including the functioning of large conglomerates. Two points are relevant here.
The RBI, the oldest financial sector regulator, has already been, fulfilling nearly all the other objectives that the new Council will be entrusted with. Its quarterly credit policy statements have emphasised these as part of the monetary stance. The RBI's role in insulating the Indian economy from the global financial crisis is well known.
In fact, among central banks and other financial regulators of the developed world, the RBI's functioning is cited as something worthy of emulation. There is no case at all of diluting the RBI's role in the guise of setting up a new Council.
The second objection to a Council is that it might become ‘a super regulator' over time, especially, if, as is rumoured, the Finance Minister is going to chair it. A political head for a regulator charged with maintaining financial stability is never a good idea. Besides, a super regulator will for all intents and purposes become a unified regulator.
As a general rule, a political head will be more susceptible to outside interference. The point is particularly relevant in the context of giving the proposed Council the task of supervising financial conglomerates.
Global experience
One needs to look at the experiences of other countries with regulation. Before the crisis, the idea of a unified regulator was popular in rich countries.
In the U.K., the Bank of England was asked to surrender prudential regulation which was then merged with the unified regulator, the Financial Services Authority. That proved to be a serious handicap as the crisis unfolded. Prudential regulation of banks goes hand in hand with the central bank's role as the lender of the last resort.
Finally, the idea of having a unified financial sector regulator over the medium-term is borrowed from the Raghuram Rajan Committee on financial sector reform. The committee submitted its report in September 1998, days before the global crash. It is unlikely that the committee would have persisted with its recommendations on financial sector regulation if it had released its report a few months later.
