1. The proposed Indian Financial Code: Venturing into an unknown territory

The proposed Indian Financial Code: Venturing into an unknown territory

It will be challenging to get six financial agencies with criss-crossing functions to meet and talk on a common plane for arriving at a coordinated solution

By: | Published: July 30, 2015 2:30 AM

The proposed Indian Financial Code (IFC) cannot be criticised for being wrong as there are various templates for managing financial systems across the world and this is one of them. Central banks across countries have different roles and there is no stylised list available for use. The way our system evolved, the central bank became all-encompassing, which made it convenient to coordinate financial decisions as it developed expertise in all areas for this purpose. That said, it is also a truism that implementing this code would mean fewer powers for RBI, which will be more involved with managing the banking system and less empowered to frame independent policies as there are other overseeing agencies in charge.

The six financial agencies spoken of by the IFC—Financial Authority, RBI, PDMA, FSDC, Financial Redress Agency and Resolution Corporation—would all be taking on the responsibility of managing domains that were hitherto under RBI. An interesting future development would be whether or not these six agencies would be monitored by the ministry of finance or would be independent given that they would be run by persons appointed by the ministry. Now, whether it is better or not than the existing system can only be evaluated with time. Interestingly, the IFC talks of a chairperson of RBI, and it is unclear whether it refers to a new person being designated or the RBI governor being called the chairperson in the new trimmed down structure.

The existence of the Financial Authority which oversees all non-banks and payments systems could mean that other segments of the market such as securities, commodities, NBFCs, MFIs, insurance, etc, could be classified as coming under this purview. There needs to be clarity on these structures as there other regulators in the picture.

The Redress and Resolution agencies are definitely needed to protect consumers and there can be some merit in having an independent entity which controls this function. Often it is felt that the consumer gets an unfair treatment when dealing with banks—like the number of ATM withdrawals or cheque books being charged—and hence an independent agency to address these grievances could be a better option. Again, while talking of protecting consumer interest, clarity is needed on whether these agencies cover issues in banking only or also securities, insurance and pensions. As a corollary, the role of Appellate Tribunals and Ombudsman has to be reviewed.

The more contentious issues pertain to the way RBI will conduct monetary policy, and the creation of the PDMA and FSDC which again replace RBI in specific functions. This is so because there is a strong link between the three. The monetary policy committee is to have three persons from RBI and four appointed by the government, which makes it in general a non-RBI majority. Now one is not sure as to whether the four government appointments would be officials or nominated outside experts. The former will automatically mean that the government will have the last word with interest rates. The latter could be seen as independent but would run into the same problem of directors who are appointed on company boards who do not actually function as independent directors. The RBI chairperson will not have a veto or overriding, say, in the decision and can have a decisive vote only in case of a tie.

The IFC further says that RBI will be finally answerable to the government if inflation is not controlled. This will make it challenging for RBI. First, the institution does not have a final say in the conduct of policy. Second, it has only one lever to deal with, i.e. interest rate. Third, it is targeting an inflation rate as measured by the CPI, over which it has no control as most components of the CPI are outside the purview of interest rates. Therefore, RBI will have a tough time managing these forces.

Now if we look at the PDMA, the mandate is clearly to keep cost down for the government and also make the market more liquid. These are the functions of RBI today. The PDMA would typically like to push interest rates down; and the operations of RBI in the secondary market through OMOs could be hampered by the pressures put by the PDMA. RBI could become a secondary player in the market.

Finally, the FSDC is to evaluate the risk in the system and manage the same. By implication, the Financial Stability Report that is brought out by RBI will now be authored by the FSDC. This aspect of the functioning of RBI was closely related to regulating banks and ensuring the soundness of the system. The IFC now transfers this responsibility to another agency.

Putting all these pieces together, RBI will be left with a smaller share of responsibility in terms of managing the monetary and banking systems. At the same time, it has to take the onus for explaining why things are going wrong without having the equipment to rectify them in the system. The problem really is that each of these agencies could have a different view, which though justified, has to be put together with one face. Currently, being the central bank with extensive powers, RBI is able to put them together and resolve the issues. With different agencies, we will still require a coordinator, especially so as there can be opposite views given the self-interest of each regulator.

A curious observation is that we already have a plethora of regulators in the financial space, such as RBI, SEBI, FMC (now under SEBI), IRDA, PFRDA, NABARD, SEBI (MUDRA?). We needed far more coordination between these regulators as all had to see the picture from a broader view. Now with six financial agencies, with criss-crossing functions, getting to meet and talk on a common plane for a coordinated solution will be a challenge.

Is this a right thing? A hard question to answer, as RBI has shown consistently over the last two decades that it has managed the system in an exemplary manner and taken the level of supervision and regulation to the highest levels. In fact, not once has the monetary authority been faulted for an incorrect action. RBI has tackled problems with dexterity and kept our system sound even when there were global crises. If the same is displayed equally by all the new agencies, things will work well.

Now, RBI will face the toughest challenge of being a goalkeeper defending both ends.

The author is chief economist, CARE Ratings. Views are personal

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