Column : Commission and omission

Written by Sandeep Parekh | Updated: Apr 10 2013, 05:33am hrs
If reducing the number of states in India would solve all of Indias problems, we would have abolished states long ago

I must confess that reading the Financial Sector Legislative Reforms Commission (FSLRC) report made me feel like I had entered the world of the Matrix (the movie). There were premises and hypothesis interconnected to each other, powering the proposed amendments for rewriting all financial laws in India. One can hardly imagine the finance ministry analyse a system-wide database in step one and prevent a systemic crisis in the fifth. A bit like the deus ex machina or god out of the machine from the Greek playswhere the plot is stuck at the end, and there is literally no resolution. And, whoa, a crane comes from nowhere with a Greek god sitting on its end, lands and solves the entire set of problems, and of course there is a happy ending. While the report veers into abstract and untested theories at times, there is of course much to like about the report. I will try to bring out both the good and not so good parts of the report.

The five good things I would unconditionally praise are as follows. First, the concept of ownership neutrality. The report correctly states that giving preferential treatment to public sector units distorts the market. All public sector bodies must operate within the regulatory superstructure applicable to other competitors. Second, the report highlights the need for transparency, accountability and a consultative approach before enacting new regulations. This includes a rigorous cost-benefit analysis of new regulations. Third, the concept of disinterested administrative law judges sitting inside the regulator reduces the perception or reality of the regulator acting as judge, jury and executioner. Fourth, the draft bill is very well drafted and should be the benchmark for any future overhauling of any regulatory authority even if it is not adopted by Parliament as proposed. Finally, a clearly stated objective of RBI in its monetary policy will bring substantial clarity and transparency of objectives without interference from political forces (but for other sources of interferences proposed).

The five things I would change are as follows. First, as argued by the dissent note of PJ Nayak, two decades of empowerment of financial regulators is sought to be reversed with this report. The hideous governmental regulation through the controller of capital issues caused untold misery in the capital markets. Substantial powers are sought to be taken from RBI and other regulators and given to the finance ministry. These include such important areas as crisis management and monitoring systematically important institutions. A task globally given to a central bank and a task the finance ministry would have no apparatus to deal with.

Second, connected to the first, creating a statutory body called the Financial Stability and Development Council (FSDC) chaired by the finance minister, which will sit over the regulators, would further take away the independence and expertise of regulators, is regressive and deeply disturbing.

Third, the infatuation of the report with principles-based approach to regulations as opposed to the rule-based approach is wrong. Financial regulations cannot be principles-based. Imagine a principles-based requirement that margins collected should be fair replacing the current mathematically determined number. I can think of no more than a part of the code of conduct of intermediaries (which already is) and few other things possibly being principles-based.

Fourth, there is no internal consistency of reducing the number of regulators to reduce regulatory arbitrage. Either there should be one regulator for the entire financial sector if the story is that there is possibility of gaps and turf wars between regulators, or the status quo should continue. Why does regulation of banking and payment systems continue with RBI Creating a different alphabet soup of regulators, seven-strong, cannot be consistent with the story of gaps and wars. Similarly, creating a separate Financial Redressal Agency does not add any valueoften the problem is with the quality of the regulation rather than with its redressal, for example charging 40% commissions in financial products may be legal but is not desirable as permissible. Thus, where the substantive regulator passes improper laws, the redressal agency will be handicapped in enforcing what would clearly be legal and clearly wrong. There will be a new game of football between the substantive regulator and the redressal agency, to name but two of the proposed seven regulators. In addition, if merely reducing the number of states in India would solve all of Indias problems, we would have abolished states long ago. There is a solution for gaps between regulators and the Constitution of India does that simply between the states and the Centre by giving the Centre power over residuary areas. The fundamental problem is the quality of enforcement of our regulators, rather than a once-in-a-20-year turf war between two regulators.

Fifth, the concept of a Resolution Corporation that is able to track tens of thousands of corporate entities which make highly intense promises to consumers and catch them in the act even before they are bankrupt seems a bit of impossible. How can one possibly guess a firm is going to go bankrupt sitting in a regulatory ivory tower. Even the boards of Lehman Brothers and Bear Stearns didnt know they were going bankrupt (the Board of Lehman was discussing multi-million dollar bonus payments shortly before) and the board of Goldman Sachs did not know they would survive (they were successfully rescued).

All in all, this is a good report and even if there is staunch opposition to the recommendations, and political priorities lie elsewhere rather than a bill on something of no interest to political parties, and positively opposed by some ministries. However, large parts of the report can be salvaged and used. In fact the draft bill attached can be used as a benchmark for future overhauling of various Acts, one step at a time. Various ideas of accountability, consumer focus, cost-benefit analysis (see our firms recent paper on this at bit.ly/YdsG9X) should be immediately adopted by various regulators without statutory amendments. The emasculation of RBI and the other financial regulators should be immediately junked without a second thought. The government is simply not good at regulation and putting the government in charge of not just the fiscal situation but also the monetary policy of India and financial crisis management sounds suicidal, besides risking politicisation of regulators and the central bank. The Roman god Janus with two heads looking in opposite directions, and god of beginnings and transitions, would advise caution ahead.

The author is founder of Finsec Law Advisors and visiting faculty at IIM, Ahmedabad