Soon there will be one

Indian Express, 3 May 2010

On the issue of unit linked insurance plans (ULIPs)and their regulation by SEBI (Securities and Exchange Board of India) or IRDA (Insurance Regulatory and Development Authority), the Supreme Court has remarked, "Why not appoint a super regulator." This is a crucial point and in the long run India needs to move towards unification of all financial regulation into one agency. But there are reasons for not undertaking this integration right now. However, it is necessary to have better coordination among regulators, reduce the number of agencies, and streamline the role and function of regulators. The tasks of financial regulation in India are spread across an alphabet soup of agencies: SEBI, IRDA, FMC, PFRDA, RBI, DCA, etc. In many cases (Forward Markets Commission, Reserve Bank of India, Department of Company Affairs), these functions are defined by legislation drafted many decades ago, when financial markets were unrecognisably different. Bureaucrats have shied away from “treading on turf”, so even reform proposals have avoided taking functions away from an existing regulator.

But the world of finance is changing fast. Technological and financial innovation involves combining ideas from across the financial landscape, and combining them in innovative ways. While the old system appears to have worked well in its time, it is coming under increasing stress.

Banks used to be regulated by RBI, but banks now perform depository participant services and trade on securities markets, which are regulated by SEBI, and sell insurance products that should be regulated by IRDA. There are complexities when faced with supervisory problems of banks performing depository services: would these be dealt with by RBI or by SEBI?

The ULIPs question amounts to asking: when a product is a combination of insurance and fund management, how should it be dealt with? Similarly, NSE and BSE will soon have trading in futures on gold units, while FMC regulates futures on gold. Who should regulate these?

In recent years, there have been many instances of a breakdown of consumer protection, with high pressure salesmen selling mutual fund and insurance products. This has resulted from the lack of coordination between IRDA and SEBI: when SEBI has moved forward on improving consumer protection, IRDA has been concerned about the market share of insurance companies and held back on replicating similar moves. The regulatory structure has failed to provide desired levels of consumer protection.

Many times, the natural progress of the Indian economy is held back by regulatory conflicts, as has happened with FMC trying to block NSE/BSE trading of futures on gold units, or RBI holding back the emergenceof the Bond-Currency-Derivatives Nexus since it would largely happen on SEBI-regulated exchanges. This had led to delays in introduction of financial instruments. A good regulatory structure should have combined the objective of consumer protection along with providing an environment that encourages finance to witness healthy growth. The multiple-regulatory framework has not been able to provide this. India is paying a price for this lack of reform.

The solution for the long run is the unification of all financial supervision into one single agency. The government would set up an Indian Financial Authority and all activities of all financial firms would be supervised by this one agency. This would ensure internal resolution of questions such as insurance versus mutual funds or currency futures traded on exchanges.

It is not hard for Parliament to achieve this unification, given the lack of political economy complexity in finance. While bureaucrats might think that merging FMC into SEBI or moving debt management out of RBI are big events, they are actually minor problems in the eyes of politicians, given that no voter cares about how these things are done. Indeed, if the framework is able to provide better consumer protection and a lower probability of scams, most politicians would support such a regulatory structure.

Yet, there is good reason to tread softly in this direction. A single regulator would result in concentration of power. India needs to first make progress on establishing an elaborate system of checks and balances to keep these agencies on track. This involves rule of law, transparency, appeals procedures, reasoned orders on websites, the development of case law, vigorous criticism from the press and from capable think tanks. It needs regulated entities and practitioners who are confident enough to criticise regulators. India has begun on one interesting experiment, of SEBI, where a system of checks and balances is being constructed. Until we have the confidence that these checks and balances are working well, concentration of power should be avoided.

The second problem lies in the appointments process. The UPA has done a fairly good job of many critical appointments in finance. But in general, the appointment process is still non-transparent. If one incompetent individual was to get the job of leading the Indian Financial Authority, this would have disastrous consequences. At present, while individual agencies experience bad periods from time to time, progress in finance continues owing to the balancing factor provided by other agencies.

While this is not the time to build a super-regulator, there is a lot to be done on simplification and rationalisation of the structure of agencies -- the unification of regulation of all organised financial trading into SEBI, the separation of debt management functions which are presently at RBI into the National Treasury Management Agency and the separation of banking regulation from within RBI into a Banking Regulatory and Development Agency. The creation of the Financial Development and Stability Council will improve inter-regulatory coordination, and bring greater unification for the critical function of monitoring Large Complex Financial Institutions (LCFIs). These reforms will yield immediate gains. Over time, once all these things have fallen into place backed by a new set of laws, and the policy community feels confident about checks and balances and the appointments process, India can and should move on to setting up a single super-regulator for all finance.

In the Union Budget speech Finance Minister Pranab Mukherjee announced setting up of the Financial Sector Legislative Reforms Commission. This body would look into outdated laws in the financial sector and propose ammendments in keeping with the Indian financial sector of today. It clearly has a challenging job ahead.

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