G N Bajpai: Budget 2006 - Some recommendations

The Indian economy needs the vitality of a robust financial system, which the Budget can provide

At the beginning of the economic reforms in India in the early nineties, the focus on the financial sector was substantial. This led to the abolition of the office of the controller of capital issues, the constitution of independent autonomous regulatory bodies, and the opening of sectors including insurance (the last in the series). The securities market made a triumphant paradigm transition from merit-based regulation to a disclosure-based regime. The reforms pursued have "... transformed [the] stock market from [a] proverbial den of thieves to one of the most transparent automated well regulated in the world ..." (a la Steve Vickers, President""International Risk, FinanceAsia.com).

The reforms have enhanced the quality and solidity of other segments, eventually enabling the financial system to weather the storms""macro and micro, domestic and global, including the Asian meltdown. However, the pace of reforms in different segments has not been organic and with equal momentum and rapidity, giving rise to laggards and systemic vulnerability. In fact, within the financial system some segments are not able to keep pace with others. Some of the recommendations outlined below may help in remedying the situation.

First, the finance minister should implement the proposals in last year's Budget: the enactment of the Pension Regulatory Authority Bill, integration of the securities and commodities futures market regulations, ensuring effective interplay of "key drivers of [the] banking sector: competition, consolidation and convergence", implementation of the recommendations of the expert committees on building the vibrancy of the debt market (cash and futures), the regional financial centre in Mumbai, etc.

Second, eliminate conflicts of interests. Ownership and regulation in quite a few areas are vested in the same authority. The Centre and state governments own a large number of public undertakings and they also lay down the guiding principles for the functioning and regulation of industry as well as individual entities. The RBI has an 85 per cent stake in State Bank of India (SBI), has owner nominees on the board, and regulates the banking industry as also SBI. The Centre has a majority holding in all public sector banks and serving officers on the boards, while the banking division performs a regulatory role. Ownership has to be de-linked from regulation because the two often do not work in harmony, militate against the efficacy of the system, and result in conflicts of interest. Since ownership cannot be divested, regulation should be left to independent bodies and no exception should be made. It is time to separate banking supervision and regulation from macro-economic policy management.

Third, unify regulatory jurisdiction. In the case of listed companies, regulation is fragmented between the ministry of company affairs, Sebi, and, in a few areas the ministries, including finance, dealing with the business of listed companies. Fragmented jurisdiction creates chinks in regulation, giving space for wrongdoers to take shelter. Further, the convergence of industries is focused on discovering "opportunity zones without boundaries", which poses substantial challenges to regulators. They need to co-operate more than before, take a co-ordinated approach, build common standards, and strike a balance between the safety of the market and the creative genius of the participants. The co-ordinating structure among regulators of the financial sector is informal, nebulous and ineffective. Issues of co-ordination are serious and need a legislative approach.

Fourth, build a formal, potent, and effective co-ordinating arrangement for the efficacious regulation of intermediaries. Currently, the same intermediary sells varied products, which in turn are overseen by different regulatory authorities. An inadequacy of skills and development of the sector and the regulatory framework, and the absence of synchronisation, leave plenty of scope for mischief mongers. As for the so-called firewalls, there is neither fire nor walls in most cases. This is not to suggest putting everyone in shackles. On the other hand, regulation should define broad frameworks/parameters. Market participants should have the freedom to operate within that framework, without intervention. The attention of regulators should shift from risk orientation to risk-specific tactical choices""tool selection in time, and intervention and regulation.

Fifth, build a legislative mechanism for efficacious harmonisation of what happens on the trading platform and over-the-counter (OTC). Globally, while some products flourish on the trading platform, others do so in OTC markets. OTC trades are opaque and non-transparent, but facilitated. A trading platform is transparent with wide participation, but process-driven. Harmonisation will eliminate the weaknesses and bolster the strengths of the two segments, and thus make the financial system more protected. While inspiration should be drawn from global experiences, market forces here should determine which should flourish where. Academic cubicles should not seek to dictate market forces, which is like commanding the waves. Inadequate co-ordination engenders arbitrage opportunities, which can be perilous to the system.

Sixth, initiate, encourage, and even incentivise, but not by providing subsidies and tax breaks in financial innovation, particularly in the area of product development. Risk management needs tools and market breadth. Financial products should themselves be facilitators. The issues of regulatory jurisdiction should not be allowed to hijack the development of the financial system.

Seventh, over time replace "gradualism" with initiatives, interventions, and perspective. The rapidity and profundity of the changes is overwhelming and a speedy response is vital. When someone asked the author, when he moved from LIC to Sebi, how he would describe the change, this was my response: "There is no dull moment in the life of the securities market regulator." When he heard the response on his visit to India, Sir Howard Davis, the then chairman of the Financial Services Authority, UK, added, "And it is never too early to panic." In fact, the regulatory approach should undergo a paradigm shift, transiting from being enforcement-oriented, reactive, adversarial, and incident-driven to being one of compliance and partnership-oriented, preventive, and problem-solving.

Eighth, unlock shareholders' wealth to deliver greater value for the welfare of the country. Disinvestment is essential to pool in fiscal resources for building physical and social infrastructure, which will eventually help in poverty alleviation and enhance market breadth. Gold in the locker does not deliver returns. And unlike gold, the value of the public sector does not appreciate with time and does often depreciate. History is witness to this.

The Indian economy has entered the race for economic resurgence. Currently, its pace is enviable. However, it needs the vitality of a robust financial system, which can be ensured by regular rejuvenation. Let some part of the Budget be devoted to the building of the financial system of tomorrow.

The author is a former chairman of LIC and Sebi