A financial idea whose time has come

The Hindu Business Line, August 07, 2015

By Pradeep S Mehta
The Indian Financial Code has the potential to modernise finance regulation in India; status-quoism shouldn’t spoil it

Lord Denning was one of the most influential and revered common law judges of the past century. Considered much ahead of his times, the English judge was always willing to reflect upon novel possibilities and solutions.

Lord Denning succinctly articulated his approach in his 1953 decision in Parker v. Parker as, “And what is the argument for the other side? Only this that no case has been found in which it has been done before. That argument does not appeal to me in the least. If we never do anything, which has not been done before we shall never get anywhere. The law will stand still while the rest of the world goes on and that will be bad for both.”

Lord Denning considered development and evolution of law as a necessary condition, to suit the changing requirements and needs of the society. And he would have been particularly concerned to note that Indian financial sector is still governed by, inter alia, age old Reserve Bank of India Act and Insurance Act, both enacted around 80 years ago.

While these legislations have been intermittently amended, they have avoided a comprehensive re-look, until the advent of Financial Sector Legislative Reforms Commission (FSLRC).

The FSLRC was set up in 2011, with a mandate to rewrite and clean up the financial sector laws and to bring them in tune with current requirements. It drafted an Indian Financial Code, to regulate the financial sector, and submitted the draft Code to the government in March 2013. A revised version of the draft Code was released for public comments late last month. As economist Ajay Shah notes in his blog, the revised version is much more orthogonalised than the earlier draft: general concepts are being consistently applied and the drafting is clearer and simpler.

More than monetary policy

Since its release, unfortunately, the debate on the Code has been limited to a minuscule (yet significant) portion regarding design of the monetary policy committee.

The Code actually marks a shift from rules-based regulation to principles-based regulation, and introduces comprehensive changes in financial sector governance. It proposes an outright repeal of 19 laws, including the RBI Act, Insurance Act and SEBI Act, and amendments to close to 40 legislations.

Regulations issued by different regulatory agencies will have to be reviewed and revised to ensure compliance with principles mentioned under the Code. It also proposes merger of all financial regulators other than the RBI and setting up of new and specialised agencies such as the Public Debt Management Agency, Resolution Corporation, etc.

Consequently, the Code is expected to have far-reaching consequences in the operation of financial sector, and deserves a wider debate and discussion.

Let us walk through some key principles which the Code proposes to introduce, including some critical changes between the two versions of the Code.

Financial consumer protection

The Code puts financial consumers at the heart of the financial sector ecosystem. All regulations under the Code will have to pass the litmus tests of consumer protection and promotion of public awareness about financial products and services. Regulators will have to particularly care about vulnerable retail consumers who are expected to have limited knowledge and experience in the financial jungle.

It is heartening to note the revised draft extends this responsibility to financial service providers who also are required to consider differences in knowledge, experience and expertise of consumers, while dealing with different kinds of consumers, and cannot adopt a ‘one size fits all’ approach.

Accountability mechanisms

Being principle-based legislation, substantial work of writing regulations has been delegated to financial agencies, under the Code. To ensure such delegation does not result in abuse of power, stringent accountability mechanisms have been put in place.

These include furnishing of reports and returns to the Centre, including the annual report, which is expected to contain a report on performance and efficiency of the financial agency, a statement indicating any statutory obligation that such agency or its board has not complied with, and reasons for such non-compliance.

It is required to be laid before Parliament. Adding to these requirements, the revised version of the Code requires the board of the financial agency to evaluate performance of each member, which is a step in right direction.

Need for urgent adoption

Most criticisms of the Code arise from the fear of unknown, and status-quoism. How will the new regulatory landscape pan out? Why is there a need for such big bang reforms when our financial sector has weathered the storm of global financial meltdown?

Most such arguments would have fallen on the deaf ears of Lord Denning. The right questions to be asked are: are we satisfied with the current pace of financial sector development?

Where do we see ourselves in competition for global finance a decade from now? Comparing a regulatory scenario in which the Code has been adopted, with the one sans it; I would certainly be more comfortable with former.

Yes, there would be implementation challenges and capacity constraints, and stakeholders will need to work towards addressing those. Financial service providers and regulatory officials might feel overwhelmed with the changes and developments in a short-term, but the benefits in medium-long term, from adoption of recommendations of FSLRC and Code will immensely outweigh such short-term pain.

The FSLRC and Code gels well with the other reform initiatives the government has been working on. These include the Regulatory Reform Bill, which, like the Code, aims to achieve uniformity in regulatory governance of infrastructure regulators; and GST, which will aid in efficient allocation of capital cheaply raised through implementation of Code.

Consequently, the Code must be urgently adopted as, in the words of former PM Manmohan Singh, it is an idea whose time has come, and no power on earth must be allowed to stop it!.

The writer is the secretary general of CUTS International. With inputs from Amol Kulkarni

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