Last week, the Financial Sector Legislative Reforms Commission (FSLRC) released an approach paper that encapsulated its preliminary ideas about the direction that its recommendations might take. The purpose of the paper is to invite comments, which will be part of the consultative process leading to the final recommendations.
To me, the most interesting sentence of the paper is ‘The first objective of financial regulation is consumer protection,’ but more on that later. The headline-grabbing point is that almost all financial regulation is to come under a single agency. The paper is critical of sector-specific regulatory structures as the breeding ground of a number of problems including regulatory arbitrage and regulatory capture. It lists SEBI (securities markets), IRDA (insurance), FMC (commodities) and PFRDA (pensions) as regulators that should be folded into a new unified financial agency. The RBI is the obvious exception--the paper envisages the RBI’s bank regulatory functions to continue as they are.
If one steps back a bit and sees what is being said here at a conceptual level then the Commission is recommending a switch from the current vertical structure of regulation to a horizontal one. While the main functions of the regulators are being folded into a single agency, four important functions are to be moved into agencies that will look only at those areas. There will be a single Financial Sector Appellate Tribunal (FSAT) that will replace all the current appellate tribunals. There will likewise a single Financial Redressal Agency (FRA) which will hear and resolve consumer complaints across all financial products and services. And there will still be the Financial Stability and Development Council (FSDC), which the paper says will have ‘will have modified functions in the fields of systemic risk and development’ compared to the current ones but it doesn’t go into any detail of the modifications at this stage.
The logic of these ideas is well argued in the paper. There can’t be much doubt that a unified structure and an independent consumer redressal mechanism will be far better than the current vertical structure. The worst aspect of the current system, one which has done consumers a lot of harm is that explicitly or implicitly, regulators sometimes take change in regulations to be an admission that they had been mistaken or lax earlier.
This is human nature and is unavoidable. Whether it was IRDA tightening ULIP rules or SEBI’s crackdown on mutual fund mis-selling, it took the regulators far too long to respond to consumers’ problems. An independent redressal agency would hopefully be quicker.
However, there is a one curious gap in the paper’s recommendations and that is the handling of the Reserve Bank with kid gloves. The paper has kept banking out of the scope of the verticalisation of regulatory structure. It does say that this should be revisited in five or ten years when either banking as a whole or its consumer redressal could come into a centralised agency. This is a cop-out, to put it bluntly.
It’s a cop-out because realistically, given the number of empires it has set out to destroy, even the FSLRC’s current process could take five or ten years to complete, and that too in some mutated and stunted form. The hypothetical next stage of financial regulation reform is probably three or four decades away.
But the bigger reason why this is a cop-out is that the banks have actually been the leaders in exploiting regulatory arbitrage and the RBI has been unable or unwilling to stop it. Banks’ financial distribution arms have been the most active in mis-selling insurance, mutual fund, portfolio management and other products. They are successful because they have access to consumers’ financial data and they have the RBI-given trust that the word ‘bank’ engenders.
It doesn’t matter to the consumer who does monetary policy, bank auditing or debt management but banks’ non-banking financial product businesses and their consumer redressal must be brought into an independent agency right away. The best way to do this is to force these activities into separate corporate bodies that can be owned by a bank but are regulated separately, just as their asset management or insurance businesses are.