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FSLRC on Financial Regulatory Architecture

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India’s regulatory architecture has been driven by the creation of product-specific regulators. We have multiple regulators: Reserve Bank of India (RBI) that regulates savings and credit, Securities and Exchange Board of India (SEBI) that regulates the securities market and exchanges, Insurance Development and Regulatory Authority (IRDA) for the insurance sector, the Forwards Market Commission (FMC) for the regulation of forwards and futures markets and the Pension Funds Regulatory Development Authority (PFRDA) for pension products. This approach of multiple sectoral regulators has been criticised by expert committee reports that have studied the regulatory architecture in India1. Some of the issues with the current regulatory framework that have been discussed are:

  • It creates certain conflicts of interest for some regulators. (For example, there are conflicts of interest arising from housing the functions of monetary policy as well as banking supervision under RBI)
  • Regulatory arbitrage leading to forum-shopping
  • Overlaps in regulation
  • Gaps in regulation of financial instruments (For example, ponzi schemes are not currently being regulated by any of the existing agencies)
  • Induces economic inefficiency (Many activities that naturally sit together in one financial firm are forcibly spread across multiple financial firms)
  • Reduced ability to understand risk (No single supervisor has a full picture of the risks that are present)
  • Problems of inter-regulatory coordination

The FSLRC established the following principles in order to analyse the financial regulatory architecture: (a)Independence and accountability, (b)Avoiding conflicts of interest, (c)Regulatory architecture based on a complete picture of a financial firm’s activity, (d)Avoiding sectoral regulators, (e)Increasing and utilizing economies of scale to address resource utilization issues.

The FLSRC proposed a new structure featuring seven agencies.

  1. The RBI, which will perform three functions: monetary policy, regulation and supervision of banking in enforcing the proposed consumer protection law and the proposed micro-prudential law, and regulation and supervision of payment systems in enforcing these two laws.
  2. The unified financial regulatory agency (UFA), which will enforce the consumer protection and micro-prudential provisions across the financial sector, other than in banking and payment systems. This proposed unified financial regulatory agency would also take over the work on organised financial trading from RBI in the areas connected with the Bond-Currency-Derivatives Nexus, and from FMC for commodity futures, thus giving a unification of all organised financial trading including equities, government bonds, currencies, commodity futures, corporate bonds, etc.
  3. A resolution corporation, which will implement the provisions on resolution of financial firms. The present DICGC will be subsumed into the Resolution Corporation which will work across the financial system.
  4. The Financial Sector Appellate Tribunal (FSAT), which will hear appeals against RBI for its regulatory functions, the unified financial agency, decisions of the Financial Redressal Agency (FRA) and some elements of the work of the resolution corporation
  5. The Financial Redressal Agency (FRA), which will address consumer complaints across the entire financial system.
  6. The Financial Stability and Development Council (FSDC), which will be responsible for systemic risk oversight.
  7. The Public Debt Management Agency (PDMA), an independent agency that will manage public debt

The FSLRC therefore proposes to subsume a number of existing sector specific financial regulators (SEBI, IRDA, PFRDA, FMC) into a Unified Financial Authority. The UFA would be the primary consumer protection and micro-prudential regulator for sectors other than banking and payment systems, which would remain with the RBI. There would also be a single appellate mechanism or the FSAT for appeals from all regulatory agencies. In addition, there would be an agency to address consumer complaints across the system, a public debt management agency, a resolution corporation and the FSDC.

After the proposed laws come into effect over a horizon of five to ten years, these questions need to be revisited. The FSLRC suggests two possible solutions in the long term: One possibility is the construction of a single unified financial regulatory agency, which would combine all the activities of the proposed Unified Financial Authority and also the work on payments and banking. Another possibility is to shift to a two-agency structure, with one Consumer Protection Agency which enforces the proposed consumer protection law across the entire financial system and a second Prudential Regulation Agency which enforces the micro-prudential regulation law across the entire financial system. In either of these paths, RBI would then concentrate on monetary policy.

1 – 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

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2 Responses

  1. Would you know if Cooperatives were looked at as well; which often (in practice) deliver large amount of agri credit but often are not regulated directly and NABARD is designated agency for supervision, with perhaps weaker structure and capacity to do so?

    1. The recommendation that FLSRC has made with regard to co-operative banks is that state governments accept the authority of Parliament (under Article 252 of the Constitution) to legislate on regulation and supervision of co-operatives carrying on financial services.

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