[This post is the fourth in a series on the theme “regulatory architecture of India’s financial system”. IFMR Blog will continue to feature this theme till the third week of June.]
In the introductory post under this theme, we introduced the regulatory architecture of India’s financial system, and highlighted some issues with it. For a subsequent post, we interviewed Dr. Ajay Shah of NIPFP to seek his views on why and how the regulatory architecture needs to be reformed. In this post, we present a summary of recommendations put forth by two important committees that have taken a long, hard look at the regulatory architecture to bring forth some ideas on how the architecture could be reformed to ensure development a modern financial system that India needs. The reports of these committees (The Committee on Financial Sector Reforms or the Raghuram Rajan Committee, 2009; and the High Powered Expert Committee on Making Mumbai an International Financial Centre or the Percy Mistry Committee, 2007) were released in the last few years, and therefore the analysis is fairly recent.
Committee on Financial Sector Reforms
The Committee recommended a reduction in the number of regulators, defining their jurisdiction in terms of functions rather than the forms of the players, and ensuring a level playing field by making all players performing a function report to the same regulator regardless of their size or ownership. The committee’s key recommendations in this context were:
- Consolidation of all market regulation and supervision under SEBI
In the committee’s view, the present system of market regulation spread across three agencies (RBI for government bonds and currencies, SEBI for equities and corporate bonds, and FMC for commodity futures) induces three major problems: loss of economies of scope and economies of scale for the government, exchanges, financial firms, and customers; fragmentation of liquidity, and encouragement of regulatory gaming; and loss of competitive pressure across markets, because markets operate under separate silos.
The committee recommended unifying all regulatory and supervisory functions connected with organized financial trading into SEBI. This would include equities, corporate debt, government bonds, currencies, commodities, and other kinds of products. This would include both spot contracts and derivatives, exchange-traded and OTC products.
- Consolidation of all deposit-taking entities under one banking supervisor
The committee recommended bringing all banks and any other deposit taking entities, including cooperative banks, under one supervisor – the RBI.
- Consolidation of monetary policy and banking supervision
The committee recommended continuing, over short term, with the present arrangement of both functions being under the RBI. The committee report states that though there are conflicts of interest emanating from housing both functions under one agency, there are reasons why the separation should not be immediate – given the traditionally poor inter-regulator coordination in India, if this happens between the monetary authority and the banking supervisor, it could lead to systemic problems; and other, more pressing changes need to be made in the monetary policy setting function and in banking regulation and supervision.
The committee’s view was that, India should move towards one consolidated prudential regulator and supervisor, and since this entity will be concerned with more institutions than only banks, it should be distinct from the monetary authority. Thus separation of monetary policy and supervisory authority should likely emerge in the medium term.
- Bringing all financial intermediaries governed by special statutes under general statutes
The committee recommended repealing special statutes governing certain intermediaries (eg. SBI and its associate banks, Public sector banks, LIC, GIC, etc), and corporatizing statutory corporations under the general statutes governing form of business enterprise (such as the Companies Act, 1956 or the proposed LLP law under consideration) and placed on a level playing field with all other financial services intermediaries.
- Streamlining tier 2 regulators
The committee recommended focusing the tier-2 regulators (eg. NABARD, SIDBI and NHB) on the purely regulatory function (and consolidating these regulatory activities where possible with the single regulator for the function), and separating the refinancing and other commercial functions into a different body.
- Creation of a Financial Sector Oversight Agency
Even though the Committee recommended separate prudential regulators, it called for strengthening the coordination between them, especially to remove gaps and overlaps, to remove inconsistencies in approach, to regulate and supervise systemically important financial entities, and for overall monitoring of the entire financial sector and initiation of prompt and coordinated corrective action. The committee recommended a Financial Sector Oversight Agency (FSOA) to be set up by statute, with a focus on both macro-prudential as well as supervisory functions.
High Powered Expert Committee on Making Mumbai an International Financial Centre
The committee highlighted two alternative paths, both entailing some level of consolidation of regulatory agencies:
- Consolidation of regulatory functions to four regulators
Under this path proposed by the committee proposed regulatory functions would be consolidated down to four regulators covering finance with one each for:
a. banking with a regulator separate from the monetary authority;
b. capital markets, with a merger of securities markets functions on the fixed income, currency and commodity markets into a single securities and derivatives market regulator;
c. pensions with the consolidation of pension regulation into a single pensions regulator; and
d. insurance regulator for the insurance space.
- Integration of all financial regulation into a single agency
The other path the committee suggested was to integrate all financial regulation under a single agency. The principle of the single regulatory agency is that it is able to take a complete view of all activities of all finance companies and a holistic view of trends in financial market development.
- Shift away from “entity-based regulation” towards “domain based regulation”.
The committee strongly recommended moving towards domain-based regulation, and away from the present entity-based regulation. This would entail, for example, that the banking regulator regulates the business of banking, but does not regulate all the activities of a financial firm that chooses to call itself a “bank”.
Both these committees called for consolidation of regulatory functions under fewer agencies, and making the regulation more domain or function-based, moving away from the prevailing entity-based regulation. Since the reports came out, the only recommendations on regulatory architecture that have been implemented are: formation of the Financial Stability and Development Council (FSDC), which is largely based on the concept of the FSOA proposed by the Committee on Financial Sector Reforms, and the approval of the PFRDA Act, which creates a dedicated regulator for the pension space.