Exactly one year has passed after the Lehman collapse that triggered a global economic crisis. At the anniversary of this unprecedented crisis, politicians and policy makers across the globe are compelled to institute changes that may avoid a crisis of this magnitude in the future. Seen in this context, the Finance Ministry?s plan to set up a super watchdog for the finance sector as a whole?the Financial Stability and Development Authority (FSDA)?is worthy of deep investigation and debate. By bringing the existing regulators?Sebi, IRDA, PFRDA and RBI?as equal sectoral regulators under its purview, the FSDA would become the super regulator responsible for the banking, insurance, securities and pensions sectors. I fear that though the issue is vexed, the need to bullet-list concrete steps taken in the wake of the crisis may lead to the creation of the FSDA regardless of whether or not the single regulator model is optimal for India.
The change is potentially quite significant. Over the last decade, many banks and financial institutions in India have transformed into financial conglomerates that are involved in banking as well as securities and insurance markets. Similarly, the financial products that have evolved have features that straddle these three markets. Such financial conglomerates add another layer of systemic risk to our financial system.
Nevertheless, policy makers need to guard against haste leading to waste. Some political constituents may see this as an opportunity to increase their influence in the regulation and supervision of the financial sector. Such constituents may utilise the momentum generated by bringing the proposal into the public domain to push through this change before the balance of power and opinion shifts against such a step. A rushed change may lead to the creation of the FSDA without clear objectives, with a low degree of independence, without adequately skilled personnel, and without a method to minimise turf wars that may ensue between the current watchdogs.
The worry arises because the question whether one watchdog is better than two, three or four is a particularly difficult one. Even after combing through the existing research in financial economics relating to this question, I do not find studies that convince me of the causal effect of such a change on better financial regulation and a more stable financial system. Existing studies document weak associations between the single regulator model and some measures of the quality and consistency of financial supervision. Needless to say, the gulf between a correlation and a causal link is a wide one, particularly so when the correlation spans countries that may differ along several unquantifiable dimensions. In the absence of convincing causal evidence favouring one model over the other, we need to rely on a comprehensive understanding of the pros and cons of a single, integrated regulator vis-?-vis having separate sectoral regulators. Given the intricate issues that are involved, we will undertake this exercise in multiple parts. We will survey the arguments for and against the integrated supervisory model. We will then assess the risks that are involved in the integration process and how these risks could be mitigated. In these exercises, we take the help of any existing evidence that provides associations favouring one model over the other.
Let us start by categorising the various financial regulator models that have been employed across the globe. A fully integrated supervisory agency akin to the FSDA is one that is in-charge of supervising at least three principal financial sectors, namely banking, insurance, and securities markets. In contrast, partly integrated supervisory agencies (which are in charge of prudentially supervising two of the four segments) and sectoral supervisors (which supervise only one segment) do not qualify as integrated supervising agencies.
Historically, the first countries to embark on integrated supervision were Singapore in 1982 and Norway in 1986. In the following years, integrated agencies were established in Australia, Korea, Japan, and other countries. As of the end of 2004, 29 countries had fully integrated supervisory agencies worldwide, about half of which were in Europe. National differences in the model that is adopted reflect a multitude of factors: historical evolution, the structure of the financial system, political structure and traditions, the size and level of development of the country and its financial sector. The fully integrated supervisory model can be found in a range of financial systems, from very small (e.g. some of the offshore financial systems) to large and complex (e.g. Japan), from very concentrated financial sectors (e.g. Estonia) to relatively dispersed ones (e.g. the United Kingdom), and from countries that suffered a systemic banking crisis prior to integration (e.g. Norway) to other countries with no such systemic banking crisis.
The author is an assistant professor of finance at Emory University, Atlanta, and a visiting scholar at the Indian School of Business, Hyderabad
