Reserve Bank of India governor Raghuram Rajan's memo to the central bank's employees is making news. A candid memo, large parts of which would be apt for every financial sector regulator, places a finger on the pulse of some critical elements of what ails our regulatory system.
Governor Rajan expressed concern that RBI was not seen as enforcing compliance, candidly saying that in India "we do not punish the wrong-doer unless he is small and weak". Interestingly, that is a sentence that could be said not just about India but also about the enforcement system universally. But, there is a deeper unique truth that this comment underlines about the state of regulatory affairs in India - a truth that shows the two main financial sector regulators in sharp contrast with each other.
Being a central bank focused on systemic risk and stability, RBI has largely been a paternalistic regulator - when a bank does wrong, they can get badly slapped around, but all inside the house by a strict parent, protecting the family honour in the outside world. The public domain is spared the detail of the intensity of the promise that the bank has breached, the detail of how badly the bank was out of line, and an articulation of why exactly the bank has been found to have done wrong. Detailed reasoned orders articulating what exactly was done, what the regulator is unhappy about, and how the breach is being assessed, are hardly available. What gets published is a press release stating that action has been taken.
Ask a central banker about this and she would extol the virtues of the approach, arguing that public punishment of banks leads to a larger risk to the system. If the depositors in a bank think their bank has done something seriously wrong, they would cause a run on the bank to take away their assets. This would risk others in the system, they argue, causing an adverse "externality". Therefore, when it comes to rebuking and punishing banks, the approach is a clubby hush-hush affair. If only detailed reasoned orders were passed and were made available, other banks in the system would know what they should not do to stay compliant with regulatory requirements. In other words, RBI is a regulator too focused on its role as a "prudential regulator" with its focus slanted more in favour of prescribing standards to ensure that firms hold adequate capital, control their risks and keep markets safe. So much so that it can tend to see even its own punitive actions as threats to this objective.
In sharp contrast stands the approach and attitude of the securities market regulator, the Securities and Exchange Board of India (Sebi), wearing its "investor protection" mandate on its sleeve under which lies an ever-growing-and-ever-flexed regulatory muscle. If detailed reasoned orders are hardly available in the banking sector, in the capital markets, it rains regulatory orders. There is hardly a thought given to the implications of directions ostensibly issued in the interests of investor protection. For example, for alleged violation of disclosure obligations when a listed company effected its initial public offering years ago, the company, though it has widespread ownership and extensive public interest now, can simply get debarred from accessing the capital market for a brutally long period of time. Such an approach could typically cause serious externalities and inflict damage on innocent bystanders - the very small investors in whose interest the regulatory intervention is sought to be made could be the ones getting hurt by the regulatory action.
Ask a capital market regulatory official about it and she would extol the virtues of the approach, arguing that strong action against one market intermediary or listed company would send a signal to others in the market, making them quake in their boots in fear of regulatory reprisal. So, when a company is told to refund monies of several tens of thousands of crores in a few weeks, evidently a task impossible to perform, the regulator does not care as much for achieving the refund as it cares for getting a bang for the buck in the perception game. Long orders, with flowery and colourful language that would better belong to the editorial pages of traditional newspapers, abound. In other words, Sebi is a regulator too focused on its "investor protection" role, with its focus slanted more in favour of being a policeman dreaded on the street where he has his beat. So much so that it can tend not to notice that its punitive actions could be threats to its own objective of protecting investors.
Identical legal provisions in the banking law and in securities law, conferring the power to issue directions (in the interests of depositors, in the case of RBI, and in the interests of securities market investors, in the case of Sebi) have led to completely different outcomes. RBI sparingly uses this power while Sebi has made the term "11B Order" a household name.
Each regulatory body mirrors the leadership style of the head of the organisation even while ensuring that it changes the thinking of the person occupying the chair. There is a crying need for each of them to move away from the opposite ends of the spectrum that house their comfort zones. Each organisation has zealously guarded against efforts to merge their activities. Both organisations are scheduled for a change of guard this year - something that may bring about a common meeting ground. Watch this space.
(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.) somasekhar@jsalaw.com
