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8/10/2015 Newfinancialcommission:afaultyroadmapOPINIONTheHindu

Newfinancialcommission:afaultyroadmap
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T.C.A.SHARADRAGHAVAN PRINTTT
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WhilecountriesintheWestaregivingtheircentralbanksmoreauthorityandregulatory
powers,IndiaisproposingasystemtoreducetheRBItoashadowofitself
AmidallthetalkaboutaNewFinancialCode(NFC)and
thehullabalooaboutthegovernmentsapparent
attempttocurtailthepowersoftheReserveBankof
India(RBI),somedeeperquestionsseemtohavebeen
missed:whatistheexactaimoftheproposedIndian
FinancialCode(IFC)?Whatisittryingtofix?Isaneed
forafixatall?

Muchofthediscussionhasrevolvedaroundthe
proposedcreationofaMonetaryPolicyCommittee
(MPC),whichistoberesponsibleforallmatters
relatingtomonetarypolicy.Theargumentinfavourof
anMPCisthat:itisstandardpracticeworldwideto
haveacommitteeinchargeofmonetarypolicy.Sofar,
IndiahasgiventhatresponsibilitytotheRBIand,in
particular,toitsBoardofDirectors.

And,thoughthereisnospecificprovisionforthisintheRBIAct,theBoardhas,byandlarge,entrustedthe
RBIGovernorwiththatresponsibility.So,tothemediaandtothelaypublic,thefactthattheRBIhascutor
raisedinterestratesissynonymouswiththeGovernorhimselfdoingit.

Conflictofinterest

TheproposedMPC,composedofsevenmembers,themajorityofwhomaretobenominatedbythe
government,willtakeoverfromtheRBIallaspectsofmonetarypolicy,includingthesettingofinterestrates.
Thishasriledupalargesectionofeconomists,bankersandcentralbankers.Thegovernment,theysay,should
notbeinchargeofmonetarypolicy.

Thepotentialforconflictofinterestisvast.Sofar,thegovernmenthasbeeninterestedinsecuringhigh
growthrates,notonlyasanelectoralplankbutalsoasameanstofinancevariousexpenditureschemes
proposedineachBudget.TheRBI,ontheotherhand,istaskedwithcontrollinginflation,whichoften
accompanieshighgrowthrates.Raisinginterestratesisthebesttooltoachievethis,butitalsoputsa
dampenerongrowth.

Institutingacommitteestackedwithgovernmentnominees,thus,createsaconflictofinterest.Shouldthe
committeetrytoachievegrowthregardlessofrisinginflation,orshouldinflationbetargeteddespiteslowing
growth?

Muchhasbeenwrittenonthiseventhoughitisjustoneofmanyissues.Torealisetheotherimplications,itis
importanttounderstandwhatexactlytheRBIdoes.Hint:itsnotjustaboutinterestratesofwhichthepolicy
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8/10/2015 Newfinancialcommission:afaultyroadmapOPINIONTheHindu

rateisjustone.

TheRBIsprimaryresponsibilityincludesmonetarypolicy.However,itisalsoresponsibleformaintaining
financialstabilityregulationandsupervisionofbanksaswellasoftheNonBankingFinancialCompanies
(NBFCs).ItalsoaccumulatesandmaintainsIndiasforeignexchangereservesandworksintheforex,
governmentsecuritiesandderivativesmarkets.And,lastbutnotleast,ithastheresponsibilityofhandling
Indiaspublicdebtandcurrencyrates,aswellasheadingtheDepositInsuranceandCreditGuarantee
Corporation(DICGC),whichbasicallyinsuresallbankdeposits.Inaddition,theRBIisthehighestauthority
whenitcomestopaymentandsettlementsystemsinthecountry.

Now,letsseewhattheIndianFinancialCode(IFC)proposes.AccordingtotheCode,theRBIwillcontinueto
beinchargeofmonetarypolicy(viatheMPC)thesupervisionandregulationofscheduledbankscurrency
managementandpaymentsandsettlementssystems.Thereisnoclarityyetonitsroleregardingforeign
exchangereserves,butlackinganymentionintheCode,theassumptionisthatitwillretaincontroloverthem.

TheCodegoesontosaythattheregulationandsupervisionofNBFCs,andactivitiesintheforex,derivatives
andgovernmentsecuritiesmarketswillbeunderaproposedfinancialauthority.Thisauthorityisto
regulateallfinancialservicesotherthanbankingandpaymentsystems,andwillhaveamixofnominated
membersfromboththegovernmentandtheRBI.

RegulationofNBFCs

Incidentally,thereisalreadysomegroundforconflictbetweentheRBIandthisfinancialauthoritynamely,
theregulationofNonBankingFinancialCompanies(NBFCs).TheIFCdefinesabankasafinancialservices
providerinthebusinessofacceptingdepositsfromthepublic.Underthisdefinition,alldeposittaking
NBFCswouldthenbecomebanks.Who,then,wouldregulatethem:theRBIorthefinancialauthority?

TheIFCalsoenvisagesthecreationofaFinancialStabilityandDevelopmentCouncil(FSDC),astatutory
agencyforfosteringthestabilityandresilienceofthefinancialsystem.Otherbodiesbeingcreatedincludea
PublicDebtManagementAgencyandaResolutionCorporation,whichwilltakeovertheroleoftheDICGC.

TheIndianfinancialsectorisgovernedbyahostofdifferentlawsthatwereenactedasandwhenneededto
formvariousregulatorybodiesliketheRBItheSecuritiesandExchangeBoardofIndia(SEBI)andthe
InsuranceRegulatoryandDevelopmentAuthority(IRDA).Eachofthesebodieshastakenawhiletosettle
downandstartworkingefficiently.SEBI,forexample,hastakenabout2025yearstobeeffective.

TheIFCislookingtoamalgamatealltheseagenciesintotheproposedfinancialauthoritythatwilldeemthe
RBIsofarakindoffirstamongequalsasjustoneofthemanyfinancialagencies,withtheGovernorand
DeputyGovernorsbeingdesignatedasChairmanandmembers.

So,whiledevelopedcountriesintheWestarebusygivingtheircentralbanksmoreauthorityandregulatory
powersfollowingthefinancialcrisisinthelate2000s,IndiaisproposingasystemwherebytheRBIis
renderedashadowofitsformerself.IntheU.K.,theFinancialServicesAuthority(FSA)hasbeenbrought
backundertheBankofEngland.BankingsupervisionintheEuropeanUnion(EU)iscomingunderthe
EuropeanCentralBank(ECB),andsimilarmovesarebeingmadeintheU.S.withregardtotheFederal
Reserve.

Separatingbankingregulationfromthatofother,nonbankcreditinstitutionswillcreatemanypossibilitiesof
regulatoryarbitrage,andcouldleadtofinancialinstability.

Overall,thekeyquestiontobeaskedis:whatisbrokenthattheIFCistryingtofix?ThelatestFinancialSystem
StabilityAssessmentUpdatebytheIMF,releasedbackin2013,foundthattheregulatoryandsupervisory
regimeforbanks,insurance,andsecuritiesmarkets[inIndia]iswelldevelopedandlargelyincompliancewith
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8/10/2015 Newfinancialcommission:afaultyroadmapOPINIONTheHindu

internationalstandards.

Whythenthisneedtodestabiliseawellfunctioningsystemintheprocesssidelininganinstitutionthathas
helditsownover80yearsbyrepealing19lawsandcreatingfivenewinstitutions?

Giventhewiderangingandcascadingeffectofsuchapolicydecision,afarfullerdiscussionofalltheissues
andnotjustthoserelatingtomonetarypolicy,isneededitcannotbedrivenbythehobbyhorsesofafew.

sharad.raghavan@thehindu.co.in

Whydestabiliseawellfunctioningsystembysidelininganinstitutionthathashelditsown

over80years?

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