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Regulatory overhaul needed

A plan to revamp financial sector regulation in the United States was unveiled by the Treasury Secretary Hank Paulson recently. A large part of the blame for the ongoing crisis in the U.S. financial sector, beginning with its inability to anticipate it, has been laid at the doors of the regulatory system. There is a multiplicity of regulators overseeing banks, financial services, and derivatives, and their responsibilities often overlap. There are, besides, state-level reg ulators. Not many of them could match or even comprehend the sweeping changes taking place in the financial world globally. Although the financial sector grew in size and complexity and became globalised, the core features of the regulatory system have remained practically unchanged since the 1930s. The action plan calls for the creation of three new regulators — one to ensure market stability, another to regulate banks and financial services, and the third, a business-conduct agency to oversee disclosures, consumer protection and the like. The Securities and Exchange Commission is to be merged with the Commodities Futures Trading Commission. This step will have resonance in India where attempts to merge the Securities and Exchange Bureau of India (SEBI) with the commodities regulator have so far not borne fruit. Of greater interest to India is the vastly enhanced role proposed for the Federal Reserve in its pursuit of market stability. It will supervise the entire financial sector, compile a list of systemic risks and be able to call for corrective action.

Within the United States, there are critics who think the overhaul plan does not go far enough. However, for countries such as India, the recent developments in that country hold valuable lessons. One such is in the rescue of the failed investment bank Bear Stearns by the U.S. Federal Reserve which virtually underwrote its takeover by JP Morgan Chase. Rarely has a central bank from the developed world been a lender of last resort to an entity not supervised by it. In India the clamour to bring all financial entities under one super-regulator will gather steam. At another level, the wisdom of some banks adopting the universal banking model to become a single stop financial services supermarket is now called into question. An important legislation in the U.S., the Glass-Steagall Act segregated the roles of commercial banks and investment banks. Much of the present trouble in the U.S. is traced to the subsequent breakdown of the barriers between commercial and investment bank operations.

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