A year ago, the capital markets regulator, Securities and Exchange Board of India (Sebi), asked that mutual funds not charge any entry load for investments by their subscribers. This was quite a revolutionary regulation, since it changed the incentive structure of the way mutual funds were sold to investors. Sebi was guided by two things: the cost of brokerage and distribution were anyway declining due to technology; and investors could now pay directly to distributors for services rendered, rather than have a commission sliced off their investments by the mutual fund. Prima facie this new regulation would discourage selling funds simply because they paid high brokerage or commissions to the distributor. Distributors would henceforth have to “earn their keep” by not merely pushing high-commission products as in the past, but also by becoming financial advisers to their clients. Distributors and, to some extent, mutual funds protested against this diktat, since it upset their business model. The Sebi view was that the mutual fund industry was now mature enough to be able to separate the “manufacturer” (the mutual fund itself) and the “distributor”, and there was no need to keep the cost structure opaque and clubbed together. Before the dust could settle down on this no-load rule, the rules of financial “physics” had started working.
If you plug one leak, the financial flows (i.e. commissions) would find another! Hence, Sebi raised another potent objection, this time against agents selling unit-linked insurance plans (Ulips) which have a substantial component of equity investments. Sebi’s charge was that there was a lot of mis-selling of Ulips as equity-oriented investments, rather than insurance. The Ulip sellers were not handicapped by the no-load rule of mutual funds, and there was no regulatory cap on commissions. But Ulips were products from another industry with a separate regulator, viz. the Insurance Regulatory and Development Authority (Irda). Sebi insisted that unless commissions on Ulips were capped, it would create perverse incentives and harm mutual fund sales. Hence, Sebi wanted to have a say in Ulip regulation.
Matters escalated when, in April, Sebi banned all 14 private insurance companies from issuing new Ulips. Irda asked its wards to ignore the ban. Suddenly the business model of the insurance companies was under a cloud, since Ulips contribute 70 to 80 per cent of new business premiums. The spat between the two regulators became very public, and created a lot of nervous uncertainty.
This is not the first instance of overlap of regulatory jurisdiction. For example, corporate bonds are securities which are regulated both by Sebi and the Reserve Bank of India (RBI). A more recent example is electricity futures, which fall in the turf of the commodities regulator as well as the electricity regulator. In most cases of turf tussles, there is a backroom resolution, or else an institutional mechanism, such as the High Level Coordination Committee (HLCC), or an appropriate appellate tribunal, or finally the courts. These spats are supposed to be exceptions, not routine. It is appropriate that the judiciary be the final arbiter, since there is no way to design institutions for all possible contingencies, and overlaps are bound to occur.
Irda and Sebi did not go to court, nor did any backroom amicable resolution happen. The finance ministry kept its hands off, not wanting to play favourites. The matter never came to the HLCC (chaired by the RBI governor). The dispute was finally resolved by changing the law, in essence by issuing an ordinance, since Parliament was not in session. The ordinance gives Irda primacy in the Ulip issue, thus resolving the dispute. In a gesture of furthering goodwill, Irda has imposed harsh restrictions on commissions and charges on Ulips, effectively reducing the asymmetry and “arbitrage” between Ulips and mutual funds. This resolution of the regulators’ row, while not elegant, would have been fine, had it merely filled the gap in the statute governing Sebi and Irda. But the ordinance has now created a new institutional entity which will oversee all such future regulatory disputes. The institution will be chaired by the finance minister, thus bringing in a supreme political layer over regulators.
The RBI governor will be merely a member like all other regulators. The standing of RBI is effectively downgraded. Thus the institution of RBI has suffered unwitting collateral damage in the Irda-Sebi spat. The HLCC is in danger of being sidelined or made less relevant.
The RBI’s request that the ordinance be allowed to lapse (in its current form) seems to have fallen on deaf ears, further giving credence to the theory of deliberate erosion. The proposed Bill is seriously prejudicial to the autonomy of RBI’s functioning. In its 75th year, RBI is already grappling with serious challenges of inflation, financial deepening, inclusion, a new base rate regime, credit flow and transmission mechanism and financial stability. It is framing guidelines on new entrants into banking. It didn’t need to be snubbed this way, even though the lawmakers will disclaim otherwise.
Over its entire history, RBI has discharged its mandate quite admirably, and hence earned the label of being numero uno among regulators. It has managed its multiple roles as monetary policy-maker, banking regulator and the government’s debt manager quite well.
Recent episodes of the East Asian crisis or the post-Lehman crisis are further testimony to its deft, if conservative, handling. Its leadership is acclaimed both here and abroad (in G20, BIS and other forums). One of its governors went on to become finance minister and prime minster — itself a remarkable feat in any country.
The rationale for strong RBI autonomy is, however, not merely because of its performance and track record. This autonomy of monetary policy in a context of chronic deficits, and fiscally stretched economy like India is of paramount importance. It functions in a fractious democracy prone to populist spending. It should be insulated from any trace of political oversight. It can be made directly accountable to Parliament, as in developed economies. In fact, even the appointment of the RBI governor should be made in line with that of the Chief Election Commissioner or the Chief Vigilance Commissioner, i.e. not at the “pleasure” of the government, but with concurrence from the opposition parties as well. We have a long way to go, but the ordinance is pointing us in a wrong direction.
The author is chief economist, Aditya Birla Group. Views expressed are personal
