The world?s largest economy and biggest financial centre moved closer to a complete overhaul of financial regulation at the end of last week, with the US Senate passing a Bill to that effect. From the very beginning of the subprime crisis in 2007, to the collapse of Lehman Brothers in 2008, through to the allegations of fraud against Goldman Sachs in 2010, it was obvious that something was terribly wrong with the way big finance operates. And there was plenty of public support to rein in the excesses of Wall Street. It may still be a couple of months before the US President signs the new regulations into law?the House and Senate Bills need some reconciliation?but the contours of the new regulatory structure are now clear. On one side, there is now going to be stricter regulation of activities at the consumers? end of the business. A new agency will oversee loans, mortgages and credit cards to ensure that consumers are protected from the kind of predatory lending that created the vast amounts of subprime assets in the system in the first place. This will go beyond requiring the usually unread small print put into loan/credit card documents. While this will increase bureaucracy, it is hard to object to in principle, given the circumstances.
More contentious, however, will be the new regulation imposed on financial institutions and their activities. The government will for the first time have the authority through the Federal Deposit and Insurance Corporation to break down financial institutions that become ?too big too fail?. A controversial provision that would ban all proprietary trading by investment banks?a major cause of excessive leverage?is still in, with a significant chance of being signed into law. After the Goldman scandal, there is a genuine momentum for enforcing this provision that could take investment banking back to the plain vanilla banking days of the decade gone by. Derivatives will now have to be traded in an open and transparent manner via exchanges and not over the counter. That is a very sensible move. Equally sensible is the move to empower shareholders in matters of determining executive pay and composition of boards. The conclusion of the debate on regulation in the US should help ignite a renewed debate on financial sector reforms in India. We still need to be talking liberalisation rather than control in India. And now we have a revised regulatory structure in the West to use as a potential role model. India needs a more sophisticated financial system to meet the demands of its fast growing economy. Doing nothing to promote such a system is not an option we can afford.
