<b>Pratip Kar:</b> Drawing lessons from Sebi

If the financial stability council is to play a meaningful role, it needs to be armed with statutory powers from the beginning

Animal spirits have always haunted the world of finance. Searching for a long-term stable state in the world of finance has, therefore, proved to be an illusory and a daring exercise. Since the last decade of the 20th century, we have had bubbles, currency crises and sovereign defaults leading to one global financial crisis after another every four and a half years, suggesting that financial stability is a myth. It’s like looking for a zero-entropy state in a non-isolated system. Shortly after the financial crisis in Asia, the G7 countries formed the Financial Stability Forum, based on an idea advanced by Gordon Brown and articulated in a report for the G7 finance ministers. The forum brought together regulators, central banks, finance ministers and international institutions to look at how the financial stability issues should be resolved1. It wasn’t much help as subsequent events have shown. This being the case, one may question the rationale of including the words “financial stability” in the Financial Stability and Development Council announced by the government in the recent Budget. It may haunt the working of the council in the long run.

The policy announcement of the setting up of this apex-level council — this is especially related to changes in an established regulatory architecture or policy for the first time — is bound to be greeted with sagacious debates, divergent views, a mélange of informed and uninformed opinion and a potpourri of proffered advices. Though the finance minister did mention in his speech, that the establishment of the council is “without prejudice to the autonomy of regulators”, there were apprehensions among the existing statutory regulators about the nature of the new beast. The overwhelmingly ambitious objectives sculpted for the council, couched in very general catch-all phrases such as “monitoring macro prudential supervision of the economy”; “(supervising the) functioning of large financial conglomerates”; “address(ing) inter-regulatory coordination issues”; “focus(ing) on financial literacy and financial inclusion” further exacerbated the apprehensions.

In the regulatory divinity, there is an unsaid but widely practised (and accepted) hierarchy, in which the central bank sits at the highest level and all other regulators are the children of lesser gods. A change in the regulatory architecture which could disturb that established hierarchy would be unsettling. No wonder, the finance minister was reported to have assured the Reserve Bank of India Board that the council was not intended to be a “super regulator” and it would “achieve its mandate without undermining the autonomy of the regulators”. This assurance adds to the confusion because many of the objectives set out for the council are already those that are performed by one statutory regulator or the other.

One is reminded of the times when the Securities and Exchange Board of India (Sebi) was set up in 1988 as a non-statutory body with ambitious objectives but without powers under a government notification on April 12, 1988, following the announcement made by then prime minster and finance minister Rajiv Gandhi. It is quite another matter that Sebi came to be feared and respected by the market even when it had no powers, owing to the astuteness and brilliance of the then chairman G V Ramakrishna. But, it was clear that the objectives for which Sebi was set up overlapped seriously with the powers then exercised by the Ministry of Finance, and it took four years and the onset of the economic reforms for the government to promulgate an ordinance on January 30, 1992, to establish Sebi as a statutory body and to enact the Sebi Act in April 1992.

The lessons from the Sebi experience that are relevant for the council are:

 

 

If the council is to play a meaningful role and fulfil all the objectives intended in the Budget, it needs to be armed with statutory powers from the beginning. 
 

It would be a superfluous exercise if the council did exactly the same work as does the High Level Co-ordination Committee on Financial Markets (HLCCFM), which was set up in 1992 following consultation between the then RBI Governor, the finance secretary and the chairman of Sebi. The government need not have made a Budget announcement for this purpose. 
 

There needs to be a clarity of objective and purpose, and a clear distinction between the powers and functions of different regulators, especially vis a vis the central bank; otherwise self-debilitating turf battles among the regulators are bound to ensue — this can make the council a sick child, with expectations it cannot fulfil. 
 

Although Sebi was given a statutory status on 1992, full powers were granted to it in a phased manner; gradualism and the demonstration of good work by Sebi helped it gain acceptance. 
 

This implies that there will be a need to tone down the ambitious objectives which have been laid out the for council; the Sebi Act of 1992 was, in fact, a watered-down version of the first few drafts of the Sebi Act. 
 

Among the stated objectives of the council, there are two which are important to look at. One, the supervision of large financial conglomerates which in RBI parlance are called Systemically Important Financial Institutions; this supervision itself would require a mammoth effort and involve a lot more work than just examining consolidate balance sheets. Two, regulatory coordination to avoid issues like the unit-linked insurance plan (ULIP), which are likely to crop up as our financial markets become more complicated. If the council would have fulfilled its objectives, it could concentrate on these activities in the first phase.

In addition, the council could address some of the regulatory gaps. At present, there are two glaring ones. The first is the administration of the Companies Act which still rests with a ministry. It is perhaps the only major instance where the government is retaining a policy, regulatory and a judicial role. In all other cases, these powers now rest with the sector regulator. While administering the Companies Act, the government also regulates the accounting profession as the the Institute of Chartered Accountants of India (ICAI) reports to the government. Both these should now rest with Sebi which has proved itself for nearly two decades. Maybe the current practices are the long-standing ones; but so was the Office of the Controller of Capital Issues and so was our licensing policy.

The idea of the council is laudable but much depends on the execution. But the question is: Would the council effectively become an instrument for the government to retain overall control over the regulatory architecture? The government has that power in any case. It does not need a Budget announcement only to enable this. Today, the age of innocence is lost. The financial markets are far more integrated and international in nature with massive inflows of funds than they were when Sebi was set up. Our financial policies need to be dynamically synchronised with these changes.

The author is former executive director of Sebi and is currently associated with the IFC’s Global Corporate Governance Forum of the International Finance Corporation and the World Bank Views expressed are personal

pratipkar21@gmail.com

The Objectives of International Financial Regulation by Howard Davies and David Green