It defines financial development as the factors, policies and institutions that lead to effective financial intermediation and markets, and deep and broad access to capital and financial services. Accordingly, it recognises various aspects of development of a financial system, presenting them as seven pillars of the Financial Development Index (FDI). These pillars are institutional environment; business environment; financial stability; banks, non-banks; financial markets and access of individuals and businesses to different forms of capital and financial services.
The FDR 2009 places most of the developed countries in the top rankings, with the UK holding the first rank. Amongst the emerging economies, Malaysia (22), South Korea (23) and China (26) are leaders. India is at position 38 in its overall ranking. It ranked 31 out of 52 countries in FDR 2008.
Though India is not ranked very high in its overall score of financial development, it is relatively well placed in terms of development of non-banking financial services and financial markets. Within the financial markets, India fares well in development of its foreign exchange markets and derivatives markets. Some of the sub-indicators in which India ranks well are regulation of securities exchanges and currency stability.
However, the FDR points out that the countrys institutional environment is considerably weak following its lower levels of financial sector liberalisation and low degree of contract enforcement. Indias business environment is also affected by an absence of adequate infrastructure and high cost of doing business. These areas of difficulty translate into highly constrained financial access, it notes.
Let us look at Indias institutional environment in particular. In the FDRs framework, this encompasses laws and regulations that allow the development of deep and efficient financial intermediaries, markets and services; macro prudential oversight of financial systems; quality of contract enforcement and corporate governance.
While each of these are important areas that merit improvements, one of the key issues, perhaps, is overall supervision of financial sector, as a failure on this count can be catastrophic. Regulatory coordination/oversight is now an imperative largely dictated by the recent global financial crisis. This is most aptly articulated by US President Barack Obama in his speech while unveiling the 21st Century Financial Sector Reforms agenda of the US government early this year. He is quoted below:
One of the reasons this crisis could take place is that while many agencies and regulators were responsible for overseeing individual financial firms and their subsidiaries, no one was responsible for protecting the whole system from the kinds of risks that tied these firms to one another.
He has proposed creation of an oversight council to bring together regulators from across markets to coordinate and share information, to identify gaps in regulation, and to tackle issues that dont fit neatly into an organizational chart.
In India too, currently, there are many regulatory agencies and government ministries with regulatory powers on various segments of financial markets. This structure not only leads to regulatory gaps and overlaps but is also flawed with lack of any formal arrangement of coordination amongst the regulators in matters concerning more than one of them. Rectifying this situation is more a requisite now as markets become more complex and integrated requiring the regulators to take broader, longer term and holistic view for optimal policy outcomes. Also, as financial conglomerates begin to dominate the Indian markets, a consolidated system of supervision becomes additionally vital.
The report of government committee on Financial Sector Reforms has recognised this state of affairs, recommended setting up of a Financial Sector Oversight Agency to be entrusted with the task of monitoring functioning of systemically important financial conglomerates; anticipating potential risks; initiating balanced supervisory action by the concerned regulators to address those risks; addressing and defusing inter-regulatory conflicts; and keeping a vigil on build-up of systemic risks.
This recommendation should be taken forward in the right earnest.
The writer is a civil servant.These are her personal views