Yet another regulator?

Sachchidanand Shukla

The controversy over the role of the Reserve Bank of India (RBI) and the registrar of co-operative societies in the recent capital market scam has brought to the fore issues relating to the supervision and regulation of cooperative banks. It has brought into sharp focus the need for a unified and effective supervisor. There are indications that the supervisory powers would now rest with the RBI. How much of such powers should really be vested in the central bank?

Liberalisation worldwide, coupled with technological innovation in the financial sector, has blurred the functional distinctions between traditional financial intermediaries such as commercial banking, investment banking, insurance and fund management. In such a financial system the multiplicity of supervisors result in overlaps and gaps, and as witnessed in the recent scam, this allows manipulation. Hence the demand for a single comprehensive regulator.

Professor Charles Goodhart of the London School of Economics touched upon this issue recently. He argued that if such supervisory powers rest with the central bank then, they would stretch the bank beyond its area of expertise. A central bank that is vested with greater operational independence of monetary policy would become a financial superpower if vested with unified supervisory powers as well. According to Professor Goodhart delegation of so much power to an unelected body such as a central bank is not warranted in a democratic system. He also argues that monetary management and supervisory functions may raise conflicts of interest that may impede the primary function of a central bank.

Historically, in developing countries, supervision of banking has rested with central banks. The central bank’s roles — managing payment systems, operating in markets as well as a formulator of monetary policies — are complementary in nature. Thus, supervision of commercial banks has rested with the central bank whose primary task is to maintain price stability and macro-economic management. But liberalisation has intensified competition. Despite complementarity of financial and macro/price stability, many feel that banking supervision should be delinked from the central bank and entrusted to a unified financial supervisory authority.

However, the creation of such an authority is fraught with dangers in a developing country like India. Firstly, maximum care should be taken to see that the creation of such an authority does not become a drag on the smooth flow of information to the central bank. There is every reason to believe that quality and adequacy of information leaves a lot to be desired. Yet there is a caveat here. After the doubts raised over the efficiency of the market regulator in handling the scam, is it desirable to have another regulatory body?