Financial sector reforms kicked off as part of liberalisation during the 1990s, albeit in a small way. From 2005-2011, the reforms process saw a committee-based approach, but their recommendations needed an overhaul of the prevailing regulations. Currently, our financial regulatory framework is sectoral with separate laws and regulations for banking, securities, insurance, pensions and payments.
“Such an approach is ill-equipped to deal with entities that are hybrids such as banks-cum-insurers. They face overlapping and often contradictory regulations leading to turf wars between regulators,” noted Radhika Pandey and Ila Patnaik in a paper on Financial Sector Reforms. A case in point is the turf war between Sebi and IRDAI on Ulips, which are hybrid products that provide life cover and invest part of the premium in stocks and bonds.
Sectoral regulation creates a situation of missing regulation, allowing financial entities to tweak features of products to escape regulatory oversight, besides its inability to handle system-wise risks. Regulations are also ill-equipped to deal with conglomerates whose activities blur traditional boundaries between different types of financial firms.
This led to the creation of a Financial Sector Legislative Reforms Commission (FSLRC), which formulated the Indian Financial Code (IFC), hoping to transform financial laws and regulatory functions. Broadly, the IFC had 9 key areas of state intervention under 450 sections, which were to replace the bulk of existing Indian financial law as the current approach to financial regulatory reform has been piecemeal and inconsistent. Here’s a look:
Indian Financial Code
The nine key areas of state intervention under 450 sections, which were to replace the bulk of existing Indian financial law as the current approach to financial regulatory reform has been piecemeal and inconsistent
Capital controls:
The Finance Act of 2015, through legislative amendments, provided that controls on non-debt capital flows would be exercised by the government in consultation with RBI. But, this amendment is not yet enforced and requires the government to first issue a notification distinguishing debt and non-debt instruments, which is still a work-in-progress.
State of progress
Monetary policy framework: The IFC proposed a framework with an objective to achieve price stability, while striking a balance with the objective of growth. Implemented in 2016.
Debt management:
The government proposed setting up a Public Debt Management Agency (PDMA), but rolled it back under stern opposition. Later, it had set up a Public Debt Management Cell as an interim arrangement and envisaged a two-year transition towards setting up a statutory PDMA, which too remains a work-in-progress.
Systemic risk regulation
A statutory Financial Data Management Centre (FDMC) was proposed as a repository of all financial regulatory data, to assist the Financial Stability and Development Council (FSDC) in conducting research on systemic risk in 2015. The government-appointed committee to suggest a draft FDMC Bill submitted the report in 2016, but didn’t see much progress afterwards.
Consumer protection
Three key are initiatives underway -- a financial redress agency, curbing ponzi schemes and a unified financial sector appellate tribunal. A unified Financial Redressal Agency (FRA) is a one-stop forum for speedy and convenient settlement of complaints of retail financial consumers. A task force set up to establish a sector-neutral FRA recommended a financial sector consumer protection law and even proposed an operational framework.
Public comments were invited, but a draft bill on consumer protection and commencement of the agency are awaited. As for ponzi schemes, a Bill on the banning of unregulated deposit schemes was introduced and passed by the Lok Sabha. Importantly, the draft IFC proposed a unified Financial Sector Appellate Tribunal subsuming the existing Securities Appellate Tribunal, which is a common tribunal that hears challenges against orders made by Sebi, IRDAI and PFRDA. Interestingly, there’s no appellate authority to petition against RBI’s decisions. The proposal of a unified tribunal even till today remains just that.
Resolution of failed financial firms
A task force was set up to work out a plan for the establishment of a Resolution Corporation. Then, in 2016, a draft Bill was released and public comments were sought. A year later, the Cabinet approved the proposal to introduce a Financial Resolution and Deposit Insurance Bill, 2017, but was dropped in 2018. Reason: a controversial clause that provided the option for bailing in troubled banks. If enacted it would have created a mechanism to sell a financial firm as a living concern, run bigger institutions temporarily or as a last resort liquidate them. With no mechanism to resolve, the government has no option but to use the sub-optimal measure of recapitalising inefficient banks.
Market abuse
The IFC proposed to allow regulators to direct infrastructure institutions and defined market abuse by establishing a framework for identifying and punishing persons who engage in distortion activities.
Development and redistribution
The Ministry of Finance was to be empowered to enact regulations for market development schemes or for their re-distribution. The regulations by MoF were to be enforced by financial regulatory agencies, whose objective is develop and market infrastructure, without affecting the core functions of consumer protection and macro-prudential regulation. Again, not much progress achieved on this front.
Micro-prudential regulation
The idea is to ensure the safety and soundness of financial system by reducing the probability of failure of financial firms. The IFC proposed a single law to eliminate possibility of regulatory arbitrage, even while ensuring multiple regulators to enforce the law under their respective spheres of jurisdiction. But not much work has been achieved.