Political economy of regulatory reform

Dynamic markets call for periodic reform of regulatory agencies-notwithstanding their reluctance to keep pace with developments

Though described in the Constitution in a rather prosaic manner as the “annual financial statement”, over time the budget speech has become an important instrument for policy announcements and reforms. The abolition of the Controller of Capital Issues and the creation of India’s first statutory regulatory authority or SRA, the Securities and Exchange Board of India (Sebi), was announced in the 1991 budget speech. Likewise, the creation of the Insurance Regulatory and Development Authority of India and the Competition Commission of India were through budget speeches of 1993 and 1999. We see the continuation of this practice in the post-2014 budgets. 

Overall, financial regulatory reforms have meant clarifying the role and objectives of regulation, establishing sound agency architecture and institutionalising sound governance and processes within an SRA. Typically, the Ministry of Finance (MoF) has been using expert committees strategically to arrive at a consensus on these contentious issues before a budget announcement is made. This article will look at the status of implementation of two categories of reform announcements of the last seven budgets. Seven announcements to effect structural changes in the regulatory architecture or a fundamental revision of the legislative framework constitute the first category. These are:

Illustration: Binay Sinha

1) Enactment of the Indian Finance Code or IFC— unanimously recommended by a high-powered Financial Sector Legislative Reforms Commission (FSLRC) led by a retired judge of the Supreme Court, Justice B N Srikrishna.

To strengthen and modernise the legislative regulatory framework for better governance and accountability, the finance minister (FM) said in 2014 that he will take steps for the enactment of the IFC. Next year he announced that he will introduce the IFC in Parliament. 
 

2) New monetary policy framework— recommended by many committees, including Raghuram Rajan, Percy Mistry and Urjit Patel committees.
 

The FM said it is essential to have a modern monetary policy framework to meet the challenge of an increasingly complex economy and said that the government will, in consultation with the Reserve Bank of India, put in place such a framework. 
 

3) Merger of the Forwards Markets Commission with Sebi — recommended by many committees, including the FSLRC.

This was announced by the FM to strengthen regulation of commodity forward markets.
 

4) The Insolvency and Bankruptcy Code (IBC) — recommended by many committees, culminating in the Code drafted by the T K Viswanathan committee.
 

Identifying bankruptcy law reform, that brings about legal certainty and speed, as a key priority for improving the ease of doing business, the FM announced a comprehensive Bankruptcy Code.
 

5) Creation of a public debt management agency (PDMA) — originally recommended by the RBI in 2001 and subsequently by many expert committees.
 

Recognising the need for deepening of the Indian bond market and to bring it at the same level as our world class equity market, the FM announced a PDMA, taking this function out of the RBI.
 

6) Code on the resolution of financial firms — recommended by many committees, including the FSLRC.
 

Acknowledging that a systemic vacuum exists, the FM stated that a comprehensive Code will be introduced to provide a specialised resolution mechanism to deal with bankruptcy situations in banks, insurance companies and financial sector entities. 
 

7) Creation of a unified financial redress agency (FRA)—recommended by the FSLRC.

Emphasising that properly functioning markets require proper consumer protection, the FM proposed the idea of a sub-sector neutral FRA to address grievances against all financial service providers.

The second category has two announcements that relate to the consumer —the raison d’etre of regulation. These relate to (a) the introduction of uniform KYC norms and inter-usability of the KYC records across the entire financial sector, and (b) the introduction of one single operating demat account so that consumers can access and transact all financial assets through this one account. The announcement relating to the FRA can as well be included here as it falls in both categories.

Of the seven announcements in the first category three, namely, creation of MPC, merger of FMC with Sebi and enactment of IBC, have been implemented. These are significant achievements. On IFC, however, there has not been much visible progress. In last year’s budget, the FM said that she proposes to consolidate the various securities markets related legislation into a rationalised single Securities Markets Code. Hopefully, in addition to this, we will soon see progress on IFC.

On the two announcements in the second category, we do not see much progress. Despite agreement on a KYC Identification Number, consumers today are broadly where they were on both these in 2014. The unified FRA appears to be still under discussion. In the last year’s budget, the FM announced that she proposes to introduce an investor charter as a right of all financial investors across all financial products. Hopefully this will be in addition to and not in place of the FRA. 

Given that this is one of the strongest Indian governments with a clear legislative majority, how does one explain the not so impressive record of the government in implementing regulatory reforms and consumer centric measures that was announced in Parliament? 

Both public choice theory and experience tell us that agencies are relatively easy to create but very difficult to reform. Once created, public agencies zealously guard their turf as well as the status quo. Any attempt at “reform” for better accountability or internal governance or introduction of measures to strengthen “consumer protection”, at the expense of their powers meets with stiff resistance. In the media and public discussions, it often becomes an issue of regulatory independence and regulator versus government. It requires enormous patience, domain capability and skills in the government to handle the narrative and push forward the substance of the reforms. The FM and the MoF therefore need to continue to engage with the SRAs to move on these announced reforms that benefit India and Indians but modify the turf and powers of the individual SRA and bring about greater accountability.

Given that technological and financial innovations are growing swiftly, and that protection of consumers is paramount, piecemeal interventions in response to immediate pressures is not the way forward. The answer is a coherent financial regulatory architecture with an updated IFC and a unified FRA.  

The writer is a former civil servant and member of a few for-profit and not-for-profit boards and research institutions