The 2013-14 Reserve Bank of India annual report has set out its considered views on the Financial Sector Legislative Reforms Commission’s report.

The RBI acknowledges that the Commission’s report is well researched and there is great merit in the overall approach, but it sees a number of lacunae. The RBI is of the view that there is a need to tweak a number of recommendations.

The broad approach of the monetary policy process set out by the FSLRC is in accord with the RBI’s thinking. It is here that the Urjit Patel report on the strengthening the monetary policy framework needs serious consideration.

The monetary policy objectives need to be clearly set out, and once these objectives are set out, the RBI should have instrument freedom.

It is essential that the medium-term objectives are set out by the Government, in consultation with the RBI, endorsed by Parliament and put out in the public domain.

Where the RBI differs from the FSLRC relates to the composition of the Monetary Policy Committee (MPC). The Commission envisages a seven-member MPC consisting of two RBI executives and five external members appointed by the Government.

The FSLRC fails to appreciate the difference between executive responsibility and external advice. The Patel Committee recommends a five-member MPC with three executives and two external advisers; this puts executive responsibility where it should be.

Financial redressal authority

While the FSLRC prefers a single financial regulatory architecture, the RBI is of the view that sectoral regulators could acquire information quickly and adapt regulation.

The RBI feels that the consumer protection units in sectoral regulators should be first strengthened before moving over to a single FRA.

The bane of the entire financial sector is that violation of customer rights does not invite punitive action against offending financial institutions. Any significant improvement in consumer protection is contingent on a change in the mindset of the regulators which should have zero tolerance for infringements.

The RBI is in sympathy with the FSLRC approach on the Resolution Corporation for dealing with failing firms at the least cost to the exchequer.

The FSLRC envisages that the Deposit Insurance Agency would be subsumed under the Resolution Corporation.

Two issues arise here. First, pressures to provide deposit insurance to non-bank entities will be difficult to resist. Second, who will finance the deposit insurance agency if there are large losses?

At the present time, the RBI fills the gap. The ability of the Government to meet these losses is in doubt.

Further, unlike in the case of the US where the Resolution Trust acquired real estate assets at a sharp discount, in the Indian case, by the time the Resolution Corporation acquires the troubled units, the failing firms would be empty shells — a case of profits being private and losses being public.

The RBI has reservations on the FSLRC’s recommendation that there should be one regulator instead of the present multiple sectoral regulators (of course at this stage the FSLRC has recommended that the banking regulator should be separate).

According to the RBI, the FSLRC recommendation is inadequately substantiated as regards costs and benefits. While the Commission emphasises the synergies of bringing together some regulators, it does not focus on the synergies lost by dismantling certain regulators.

The RBI’s reservations

The RBI sees inconsistencies in some of the FSLRC’s recommendations. While the FSLRC envisages regulation of organised trading of financial products being centralised with one regulatory agency, non-banking financial companies (NBFCs), which perform bank-like activities, are to be regulated by a regulator other than the banking regulator. Further, the RBI points out that the Commission proposes to entrust an agency with responsibility but the powers to exercise the tools necessary for discharging responsibility would be with another agency.

A case in point is that the RBI is charged with managing the internal and external value of the rupee, yet the Commission recommends that control over inward capital, particularly debt flows, be taken away from the RBI.

There are strong reasons for regulation of debt-oriented capital inflows, regulation of money and government securities remaining with the Central bank. These issues have been underweighted by the FSLRC.

The RBI stresses that leaving the objective of monetary policy to repeated review precludes the Central bank from acquiring credibility. The RBI feels that such objectives should be clearly set out in the Act and approved by Parliament.

Judicial oversight

The FSLRC unleashes an attack on regulators by calling them “mini states” with powers of the legislature, executive and judiciary. This is reflective of the predilection of the then powers in the Government which had been running an open vendetta against the RBI.

The RBI is of the view that submitting everything the regulator does —framing of regulations, policy decisions and the decision-making process — to legal oversight, carries the danger of depriving the regulator of its inherent powers.

The elaborate point-by-point examination of the Commission’s report in the RBI annual report should be given close attention by the Government.

The FSLRC report is the handmaiden of the erstwhile government’s open hostility to the RBI. The new government would do well not to carry this baggage. Financial legislative reforms need to be undertaken after due parliamentary process. As to the way forward on financial sector legislative reforms, all one can say is that one should not start from the obviously flawed FSLRC report.

The writer is a Mumbai-based economist