R Ravimohan: Resetting India's financial sector

The Raghuram Rajan Committee first projected a future India and then examined what kind of financial system it would require before coming up with solutions that were likely to work best in Indian conditions.

The Committee on Financial Sector Reform headed by Raghuram Rajan, former Chief Economist at IMF, and of which I was privileged to be a member, has placed a draft of its report to elicit comments from public before finalising its report. Having read a number of early comments on the report, I felt it appropriate to offer some insights into the genesis and mandate of this Committee and the significantly different approach adopted by the Committee given its unique mandate.

The Committee had a large canvass to address which was an advantage as it allowed it to review issues in totality and engineer lasting solutions. For instance, the big issue that dominated the Committee's attention was the matter of inclusive growth which was identified as a major shortcoming in the current functioning of the financial system.

The Committee examined the present policy framework, institutions and delivery mechanism and concluded that while all of these were well-intentioned and doing their best, the results were not showing up, as the current solutions were not addressing the core issues in a holistic way. Those excluded from the formal financial system lacked basic identity, track record of dealings with the financial markets, access to the financial markets and, of course, many of them were in the low income category. While many policy initiatives were seeking to increase their income by giving those sops under various welfare schemes, they continue to suffer all the other disadvantages.

The Committee has, therefore, suggested measures to provide unique identification system which a key enabler to inclusion. The Committee also recognised the regulatory bandwidth which restricts the creation of nationwide network of the formal financial system and suggested small local banks with appropriate regulatory oversight to serve people in all parts of our country.

The Committee also suggests a significant expansion of banking correspondent network to supplement the access by including grocery stores and allowing cash transactions to be undertaken at these correspondents' outlets. Further, the Committee advocates the early adoption of m-banking solutions to speed up reach and access. The Committee also understood large amounts of money that are supposed to be paid to these people by the government under its various poverty alleviation schemes such Jawahar Rojgar Yojana, National Rural Employment Guarantee scheme, and so on, get mislaid for want of a proper bank account identifiable to each individual.

Therefore, the Committee recommends the transfer of such money into pre-identified bank accounts of individuals to both insure against leakage and to create a transaction track record to help them become customers of not just banking but also insurance and other parts of the financial markets. Of course, the Committee has also recommended a series of rightly balanced regulations to ensure inclusive growth with a manageable regulatory superstructure. The Committee's recommendations, as can be seen, are addressed to solve the roots of the problem rather than deal with them in an ephemeral manner.

Similar fact-based solutions have been proposed in almost all aspects of the financial system in the country, including regulations, links between macro-economics and the functioning of the financial system, providing an even market for all financial sector players so that regulatory arbitrages are eliminated, a regulatory architecture that is right for the unique Indian market and an efficient market system that fosters innovation and is able to compete globally as an efficient, transparent, easily accessible and a well-regarded destination for investors the world over.

The Committee draws its conclusions on the final recommendations after studying issues affecting Indian markets, and studying various systems around the world and then fashioning a solution uniquely designed to succeed in the Indian context and one that is needed for the renaissance of the Indian financial system.

For instance, when dealing with the regulatory architecture, the Committee found that the multiple regulators in the system, while attempting to function in a coordinated manner, are likely to leave gaps with the financial markets growing dynamically in size and sophistication.

The Committee, therefore, recommends a unique system of formal supervisory coordination, but does not recommend a single regulator recognising the strong diversity in the various sub-systems such as insurance, pension funds and banking. The recommendation also includes sharper definitions of the regulator's mandate itself so as to impart greater clarity to its role, instead of a catch-all approach of hanging all ills of the market at the regulator's doorstep. Similarly, the Committee found that the ownership of financial players in India did not directly correlate with its ability to play public interest roles.

The current dispensation places an undue burden on public sector participants while requiring them to compete in a highly competitive market. The Committee recommends restructuring the financial sector to allow various entities full freedom to compete for capital, customers and products, while ensuring that policymakers have adequate ability to impose public policy across all players should they think such a measure is in the larger interest of the country, instead of only on public sector banks.

The Committee had the rare luxury of space and time as the mandate was to envision a financial sector a decade from now. The Committee first projected a future India and then proceeded to enquire as to what kind of financial system that India would require. Through a series of thorough assimilation of data, unbiased, objective and highly intellectual analysis, the Committee went about identifying issues that are stultifying the financial sector now and are also likely to emerge as issues in future years as our country grows dynamically.

It then scoured the world by accessing relevant experts to understand how other countries solved similar issues in their own countries. The Committee also studied the current issues roiling the world financial markets and learned invaluable lessons they had to offer. Then it evolved solutions that are likely to work best in Indian conditions. Questions of implementability, practicability, serendipity and lack of political will were factored into the solutions where considered desirable by innovative design features.

But, by and large, the Committee remained true to the cause of finding lasting modern solutions. In the next decade, the Committee expects India to march ahead with robust economic growth and hence become bigger, more powerful in the global markets and richer in its national contours. The Committee has envisaged a financial system commensurate with that of a more enabled India. The Committee also visualises that the richer, bigger and bolder Indian system will empower future leaders of India to implement more contemporary measures, such as those envisaged in the report.

Some of the solutions suggested might appear over-whelming and onerous when seen from a perspective developed in the past or even in the current context. But since the mandate to the Committee was to come up with a set of solutions that will hold the country in good stead over the next decade, the Committee, in my view, has come out with real solutions to real problems.

The author is the Managing Director & Regional Head of Standard & Poor's, South Asia. The views expressed are personal. He can be reached at r_ravimohan@standardandpoors.com