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A supreme regulator?

Central banks and term institutions in developing countries are required to promote institutions and, at the same time, regulate their behaviour. Thus, they have to combine the skills to promote and regulate markets.

THE IDEA of having a supreme command to improve regulatory performance has its seductive appeal. It is a standard bureaucratic malaise. It is, however, surprising that the Indian Finance Ministry, which is steering through its `reform process,' should fall a prey to it.

As reports suggest, the Finance Ministry wants to bring all the existing regulatory bodies in the country under one supreme regulator. It floated a note on the subject at a meeting the Finance Minister had with the heads of public sector banks on January 28. The note suggests the merger of the functions of the Reserve Bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority and the yet to be formed Pension Fund Regulatory and Development Authority under one unified command. It draws its inspiration from the U.K. model of the Financial Services Authority.

While floating the note, the Ministry was perhaps unaware or dismissive of the views of the Finance Minister had expressed at a conference organised by the IRDA on January 6. While responding to a specific query whether the country could have a super regulator like the FSA of the U.K., he said India was too vast a country to have a single regulator, but added that there was need to strengthen the existing regulators and ensure that they worked together.

It is likely that in its zeal to reform, the Ministry is concerned with the complexities of the present financial market, the blurring of areas between sectors such as banking and insurance, and more importantly, the inadequacy of regulation by the various agencies. Sadly, these issues are neither new nor original. The issue came up for debate before the Joint Parliamentary Committee that went into the stock market scam.

The quasi-regulator

In advance of the release of the JPC report, rumours were afloat that the committee was recommending the appointment of a "super regulator'' for the financial sector. In its report submitted on December 19, 2002, the JPC expressed itself against the idea of a "super-regulator" for financial markets and suggested that the High Level Committee on Capital Markets (HLC) could handle the monitoring of the financial and capital markets.

Based on the JPC report, it was in April 2003 that the Government formalised the HLC into a quasi-regulator to oversee all aspects of the financial sector. The HLC is an apex body that seeks to resolve all capital market issues coming under the domains of SEBI, RBI and the Finance Ministry. With the RBI Governor as chairman, it includes the Finance Secretary and the Chairmen of SEBI and IRDA. Over time, it may include the Chairman of the Pensions Authority as well.

There were reports that the Finance Ministry had some reservations over the formation of the HLC. However, these were over-ruled and the Government decided to establish the new HLC structure. Before coming to this decision, the Government seems to have studied the FSA and taken the view that, under Indian conditions, the existence of separate regulators will not create regulatory loopholes. Was the Finance Ministry aware of this background when it started to work on the current note?

Perhaps, it has been unduly influenced by the flood of literature on the subject inspired by international institutions. One can notice the over arching influence of an IMF document (Financial Sector Regulation: Issues and Gaps - Background Paper, August 17, 2004) on the thinking of the Ministry. Even otherwise, developing countries have been under pressure to unify regulatory agencies in the garb of convergence. Sadly, even after years of academic research, there is no consensus on the issue while global experience also belies expectations.

In an exhaustive and scintillating lecture delivered on May 22, 2001, Y. V. Reddy, the then Deputy Governor, RBI, dealt with "issues in choosing between single and multiple regulators of a financial system." He analysed the whole gamut of arguments for and against the two options and relied heavily on the work done by reputed economists like Charles Goodhart and Chandavarkar.

Dealing specifically with regulatory structure, he concluded, "Focussing entirely on regulatory structures may not be an adequate response to the current weaknesses, the changes needed in the objectives and coverage of regulation, and the emerging challenges to growth as well as greater openness in the external sector. Perhaps, the debate has to go beyond the single or multiple regulators or hybrid arrangements, while recognising some urgency for putting in place effective arrangements for regulatory coordination." As he put it, "designing and managing all these changes require a combination of political will and professional skill." In short, a country has to choose a model having regard to its own needs and may not implicitly adopt a model evolved by another country. Surprisingly, there is a smorgasbord of models to choose from!

A World Bank study by Martinez and Rose (2003) suggested that there were six main regulatory structures: the institutional or separate regulators' model; the Mexican model; the South African model; the Singaporean model; the Canadian model and the U.K. model. The U.K. model unifies regulation in the FSA and sets it apart from the central bank. Only seven countries, mostly advanced, follow this model.

The U.K. experience

Even in the U.K., its adoption was a slow process. The idea was mooted in 1997 and the bill was passed in November 2000. It became effective a year later, from November 30, 2001. It took nearly five years of intense public debate before the FSA could be established. The debate within the JPC in India was similar in nature and its deliberations led to the adoption of the regulatory structure under the HLC. Have there been any new or major developments since then which suggest that the HLC is inadequate or has failed in its role? Apparently no.

Worries over financial conglomerates and their ability to arbitrage regulatory jurisdictions are genuine. However, it is not admitted that excessive use of risk transfers, credit derivatives, special purpose vehicles to hold "toxic wastes" (as the Economist described them) are the creatures of overzealous financial deregulation. It is schizophrenic to advocate financial freedom and advocate regulatory unification in the same breath.

Central banks and term institutions in developing countries are required to promote institutions and, at the same time, regulate their behaviour. Thus, they have to combine the skills to promote and regulate markets. The RBI seems to be more aware of these imperatives than the Finance Ministry. In June 2004, it formed an inter-regulatory working group of the RBI, SEBI, and IRDA to identify `financial conglomerates' (FCs) and put them under a special compensatory lens. These efforts in league with the HLC would meet the broader regulatory concerns than an attempt to unify them.

The FSA is not the Prince Charming imagined by the Indian Finance Ministry. It has made many grievous blunders. It did not cover itself with glory in handling the issues regarding Equitable Life and was accused of failing to safeguard the interests of policyholders. The Economist (Mud on both faces, January 22, 2005) provides details of two more episodes. It reveals how the Bank of England does not think that the FSA is doing all that it could as it has augmented its own staff to do the sniffing of bad behaviour in the City! In recent days it is caught in the cross fire over irregular bond trading by Citigroup and with European regulators. While it is not necessary to vilify or underrate the FSA, there is need to admit that there is no supreme regulator who can save us from our scandals!

K. Subramanian

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