Regulating the regulators

The timing of Reserve Bank of India Governor Raghuram Rajan’s broadside against the Financial Sector Legislative Reforms Commission’s (FSLRC) report should not detract attention from its content. Yes, his unusually forthright observations have come after a new regime has taken over at the Centre. And, as we know, the FSLRC was constituted by the previous government. That said, there is substance to the disquiet expressed by him over some of the report’s recommendations.

Among these is the proposal to create a dedicated Financial Sector Appellate Tribunal (FSAT) to review decisions of regulators, including the RBI. It is nobody’s case that an RBI or a SEBI shouldn’t be held accountable for a decision to hike repo rates or impose higher margin requirements on currency derivative trades. But to subject these to legal appeal is a recipe for disaster. It is one thing to undertake a judicial review of the cancellation of a cooperative bank’s licence by the RBI. But extending this to macro policy decisions, which are essentially judgments in response to dynamic economic situations, would amount to excessive legal oversight. Unfortunately, the FSLRC has sought to allow appeals against all actions of regulators through the proposed FSAT. The best way to make regulators answerable is to subject them to parliamentary scrutiny. We need formal mechanisms that enable our elected representatives to interrogate our regulators — for instance, the RBI Governor could be questioned on why high interest rates haven’t had the desired impact on inflation even while hurting growth. This is precisely what US congressional committees do through their regular grilling of the Chair of the Federal Reserve on its monetary stimulus policies.

Rajan has an equally valid point about the FSLRC’s mechanical approach towards creating a unified financial regulator for the equity, bond, currency, commodity derivatives, insurance and pension markets. This would entail not only merging SEBI, FMC, IRDA and PFRDA, but also moving bond regulation activities, currently undertaken by the RBI, under the proposed unified authority. While it may seem rational to have a single regulator for all markets dealing with tradable instruments, the practical implications of such a move need serious consideration. The bulk of trading in bonds in India today takes place in government securities and much of it by banks. The RBI regulates the country’s banks that derive a significant part of their incomes from investments in bonds. Given this, how does vesting the trade in these instruments with another regulator help? Besides, the RBI’s own open market operations involving sale and purchase of bonds are vital to the conduct of its monetary policy. That the FSLRC has not taken cognisance of these realities only exposes the limitations of many of its recommendations. The new government should be alive to these limitations.

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