RBI bats for regulatory status quo

At a time when the banking regulatory structure is under review internationally, the Reserve Bank of India (RBI) today made a strong pitch for status quo and argued that steps taken by it had helped local financial institutions get away unscathed from the global crisis.

In its Trends and Progress report released this evening, RBI said the crisis had thrown up two key lessons that were driving the proposed regulatory review. It said that the “financial stability cannot be fragmented across several regulators; it has to rest unambiguously with a single regulator, and that single regulator optimally is the central bank”.

There have been discussions on having a single regulator for the financial sector but there has been no formal proposal for such a move.

RBI also pointed to the recent suggestions for providing a formal structure to the high-level coordination committee on financial markets (HLCC), which has representation from the finance ministry and all financial sector regulators. The HLCC, set up through an advisory from the government to RBI in the mid-nineties, is an informal platform through which financial sector regulators have taken a host of reform measures, including the ban on badla trading.

While the RBI governor heads the committee, the secretariat is housed in the finance ministry. But in recent years, there have been suggestions that RBI should not head the panel as its governor was on a par with other financial sector regulators.

In today’s report, RBI opposed the move to provide a formal structure to the HLCC. “While a formal structure will have the merit of enforcing accountability, the flip side is that it may make the forum excessively bureaucratic and detract from its other value adding features.”

Further, the report tried to put a lid on discussions over providing more regulatory authority to the Securities and Exchange Board of India (Sebi), as suggested by some expert groups.

But RBI said that unlike in some countries, the regulatory framework in India was clear. In case of over-the-counter derivatives, only those derivatives where one party was an RBI-regulated entity had legal validity, it said. The central bank also said that unlike equities, interest rates and exchange rates were key macroeconomic variables with implications for monetary policy and macroeconomic stability. Besides, RBI regulated interest and exchange rate markets, where banks were the dominant players, and was in a better position to check excessive volatility, said the report.

“This is an arrangement that has stood the test of time and has protected financial stability even in the face of some severe onslaughts. It may be desirable to continue with the present arrangement in the interest of preserving financial stability,” said the report.

RBI has also used the report to trash the debate over splitting the central bank’s twin roles as a monetary authority and a banking regulator. “The crisis has shown that there are clear synergies between monetary policy management and financial sector regulation. It is worth noting that some advanced economies where regulation and supervision are with an agency other than the central bank are themselves revisiting the regulator structures and contemplating unification,” it said.

The central bank identified at least four areas where steps were required to reduce the risk of crises and address them when they occur. One, RBI said, there was a need to find a better way to assess systemic risks and prevent their build-up in good times. Two, improve transparency and disclosure of risks being taken by various market participants. Three, expanding the cross-institutional and cross-border scope of regulation while safeguarding constructive diversity. Four, there was a need to put in place mechanisms for more effective, coordinated actions, RBI said.