FSLRC recommendations 'faddish and impressionistic': Rajan

The RBI governor, Dr Raghuram Rajan, on Tuesday attacked the recommendations of FSLRC by asking are we trying to solve a problem that does not exist?

The Reserve Bank of India (RBI) governor Dr Raghuram Rajan, while commenting on Tuesday on the report by Financial Sector Legislative Reforms Commission (FSLRC) said, the Central Bank is engaged in consumer protection framework as per the guidelines mentioned in the report. However, at the same time, he also opposed the idea of creating a Unified Financial Agency by merging all regulators, saying, "if it ain’t broke, don’t fix it!" It may be recalled that FSLRC has proposed a whole new draft law for the financial sector last year.


Speaking at the first State Bank 'Banking and Economic Conclave in Mumbai, the RBI governor said, "The FSLRC’s recommendations (on appropriate size and scope of regulators) seem somewhat schizophrenic. On the one hand, it emphasizes synergies in bringing together some regulators into one entity. But in the process it suggests breaking up other regulators, with attendant loss of synergies. There is no discussion of the empirical magnitude of the synergies gained or synergies lost, which makes the recommendations seem faddish and impressionistic rather than based on deep analysis. Indeed, across the world, we see a variety of organizational structures in existence, suggesting that there is no one right structure. If so, there should be strong arguments for departing from the status quo, which the FSLRC does not provide."


Talking about financial consumer protection laws which are lacking in India, he said, "In laying out the need for consumer protection, raising the issue of whether products sold are suitable for the target customer, and putting the onus on the financial institution to determine suitability, the (FSLRC) report has forced regulators to review their consumer protection frameworks. We, at the RBI are indeed engaged in such an exercise, informed by the valuable guidelines in the FSLRC report."


Indeed, the Reserve Bank of India has been quick in moving towards a fairer system of consumer protection rules and is engaging with different stakeholders in the process.


The FSLRC submitted its report in March 2013 and one of its key recommendations was the setting up of a Unified Financial Authority (UFA) that would merge the regulators of capital markets, insurance and banking. However, it turns out that FSLRC itself may have been an exercise in futility and a waste of taxpayers’ money. Each of its key members–YH Malegam (well-known chartered accountant and director on the RBI board for over 19 years), Kishori J Udeshi (ex-RBI deputy governor), PJ Nayak (ex-bureaucrat and former chief of Axis Bank) and JR Varma (academic)–voiced formal dissent against its core recommendations. The Commission made meagre attempts to engage with core stakeholders–the consumers of financial services–who have been getting a raw deal under every financial regulator.


Dr Rajan, while welcoming a few recommendations of the FSLRC, like the need for a clear monetary framework and creating new institutions like Financial Resolution Authority, said he sees two fundamental problem areas in FSLRC recommendations: oversight of regulators, and appropriate size and scope of regulators.


"The logic for regulation according to the FSLRC is to deal with market failure or more colloquially, bad behaviour. The Commission talks about incomplete information or poor incentives as a reason for bad behaviour, but one of the most important reasons for the bad behaviour necessitating regulation is what economists call incomplete contracts; that is, the behaviour of the regulated entity (vis a vis customers, the public at large, the taxpayer, or the market) cannot be completely specified in contracts because it is too difficult to observe or verify in real time, or it can only be gauged across many contracts," he said.


"This means that while courts can enforce specific contracts, the regulator can sometimes do better," the RBI governor said. “A bank may attract a lot of complaints from its credit card customers. While no single customer may think the case worth taking to court, and while no customer may be able to prove the bank was in the wrong, the large number of complaints will suggest to the regulator that the bank needs to shape up. By comparing the nature of the complaints it gets from this bank’s customers with the complaints it gets from other banks, the regulator can gauge whether something is wrong with the bank and act. Similarly, if a particular product attracts a lot more complaints than other products, the regulator can ask the industry to modify the product appropriately, or even ban it."


According to the RBI governor, a lot of regulatory action stems from the regulator exercising sound judgement based on years of experience and in doing so, it fills in the gaps in laws, contracts, and even regulations. He said, "Not everything the regulator does can be proven in a court of law. Courts do not interfere in the specific decisions of a corporate board. Using the business judgement rule, they do not second-guess business decisions, and only pull up boards when there is a violation of the legal process of arriving at a decision. In the same way, there are a range of regulatory decisions where regulatory judgement should not be second guessed."


Appeals Against the Regulator's Actions

Talking about the dangers of excessive legal oversight, Dr Rajan said, “one reading of the FSLRC is that almost everything the regulator does, not just the framing of regulation or the process by which decisions are reached but also the exercise of regulatory judgement as well as policy decisions, is to be subject to legal appeal. This could create problems.” According to Dr Rajan "...the process by which the regulator reached a decision, as well as the conformity of the decision with basic principles such as natural justice, can already be challenged through a writ petition in High Court. Even now, some regulatory decisions can be appealed to the central government. But how much checking and balancing is enough? Do we want even policy decisions to be appealable? Can legal oversight become excessive?" he asked.


Dr Rajan said, “we ask ask tribunals to make judgements that they simply do not have the capability, experience, or information to make, and where precise evidence may be lacking. If we attempt to do this, we will undermine the very purpose of a regulator. Of course, one could trust the good sense of the tribunal to follow a 'regulatory judgement' rule and not intervene in a broad array of matters, but does this not imply a double standard — we trust the tribunal’s judgement but not that of the regulator. More likely, though, past experience suggests that entities like to justify their existence, and if set up, a tribunal will intervene more than necessary," he said.


He said, “in India, where the financial system is developing and many new regulations have to be framed (more so if we move to a principle based approach for legislation), and where the tribunals will have a significant amount of learning to do, the encouragement to appeal could paralyse the system and create distortions, as needed regulations are held up and participants exploit loopholes.”


Dr Rajan said, in every country, a healthy respect for the regulator serves to keep participants on the straight and narrow, especially for a developing country, where private behaviour is less constrained by norms or institutions, this is important. "But," he said, "to the extent that private parties with their high-priced lawyers can check the regulator, that healthy respect dissipates. So the final danger is that the regulator could become a paper tiger, and lose its power of influencing good behaviour, even in areas that are not subject to judicial review."


Market regulator Securities and Exchange Board of India (SEBI) is already under the Securities Appellate Tribunal (SAT) and some people ask why not bring other regulators under a Tribunal. Dr Rajan, feels, as long as the Tribunal only questions administrative decisions such as the size and proportionality of penalties, there is no problem. "But if it goes beyond, and starts entertaining questions about policy, the functioning of a regulator like the RBI, which has to constantly make judgements intended to minimize systemic risk, will be greatly impaired. Indeed, because of the tendency of any new organization to overreach to justify its existence, one should be careful about tying the financial regulator with further judicial oversight. Better to revisit these issues a few years from now when both regulation and oversight mechanisms are better developed," he said.


Unified Regulator

The FSLRC has proposed that all regulation of trading should move under one roof, all regulation of consumer protection should move under another roof, but the regulation of credit should be balkanized — banks should continue to be regulated by the RBI but the regulation of the quasi-bank institutions like non-banking financial companies (NBFCs) should move to the Unified Financial Agency, a regulatory behemoth that would combine supervision of trading as well as credit.


According to Dr Rajan, this balkanization would hamper regulatory uniformity, the supervision of credit growth, and the conduct of monetary policy. "while negotiations and cooperation between regulators can overcome organisational barriers, it is not wise to give a regulator a responsibility and leave the tools for exercising that responsibility in other hands. The RBI has responsibility for managing the internal and external value of the rupee, and more broadly, for macroeconomic stability. As a number of multilateral agencies and academics have recognized, the ability to shape capital inflows is now a recognized part of the macro-prudential tool kit. But by taking away control over internal capital inflows from the RBI, isn’t the FSLRC taking away an important tool from the RBI?" he asked.


"Undoubtedly our laws need reform, but that is no reason to try entirely new approaches to legislation, overlaid on entirely new regulatory structures, complemented by entirely new oversight over regulation. Undoubtedly, we have had, and will have, periods when regulators have not gotten along with each other. But is that a reason to merge some organizations and break up others, perhaps ensuring dysfunctionality along many other dimensions? After all, there is no single regulatory architecture that has emerged with distinction from the crisis. Instead, different regulatory architectures have succeeded or failed based on the circumstances of the country and the quality of the regulator. Undoubtedly, we have also had occasions when regulators have exceeded their remit or been high-handed. But is that a reason to subject their every action to judicial second-guessing? Is there a reason we need more checks and balances, or are we trying to solve a problem that does not exist," Dr Rajan asked.



Yerram Raju Behara

2 years ago

It is so exhilarating to hear Dr Rajan's views on FSLRC and there should be no legal overhang on regulatory policies and there should be no double speak on regulation. Excessive regulation leads to business loss at a time when banks have to take appropriate risks to enhance their profits and not hide their losses in fear of either existing or impending regulation.

MG Warrier

2 years ago

In May 2013, in response to an article in a financial newspaper, I had observed: “Not much research is needed to conclude that finance ministry and FSLRC, in a hurry to resolve certain minor issues, ignored the evolution of the role of RBI and the care with which RBI has nurtured the financial sector. Fed Reserve and RBI function in two different worlds. To say that time is not right for dismantling or truncating the RBI which is doing creditably well as is being admitted in several international forums, would be telling the obvious. The dissenting notes recorded by 4 out of 7 members who signed the final report are well-argued documents, which inter alia plead the case for maintaining the basic features of RBI and assert the need for allowing the central bank to carry on with its present mandates. One wonders what motivated the FSLRC Chairman to finalize the report ignoring the difference of views expressed especially by K J Udeshi, P J Nayak and Y H Malegam. It would appear that the Commission did not get opportunity to understand the present relationship between the RBI and GOI. The regulatory apparatus plus legislations in financial sector in India are in working condition. The FSLRC’s effort to re-invent them has pushed the present regulators and supervisors to a confused state, making the possibility of an intelligent debate on the issue remote. The idea of creating a Unified Financial Agency for all financial regulators except RBI, truncating RBI by separating Public debt Management and keeping the agency doing that work (presumably with the same work force) in RBI premises, later UFA subsuming even RBI, all give a feeling that the FSLRC was not allowed to ‘apply its intelligent mind’ and in the eagerness to satisfy all, and so fast, it has forgotten its own brief. Perhaps, the purpose would be served better, if RBI is allowed to function with its present mandate, a coordination committee sorts out issues among the remaining regulators. If GOI aim is to reduce the number of regulators, after necessary groundwork, merger of the regulatory agencies outside RBI one by one, as work stabilizes could be thought of. The twin goals of one Unified Financial Agency and managing the man-power-related issues that may arise with merger here could be better handled this way.” also had published an article covering the above issues. The terse indictment of FSLRC report coming from Dr Rajan gives one the satisfaction that in India, it is not easy even for governments to ‘cut and paste’ policy formulations to suit individual whims and get away, and wiser counsel will prevail, though this may take time. M G Warrier, Mumbai

Suiketu Shah

2 years ago

Dr Swamy is right.Rajan has to go.

Hemlata Mohan

2 years ago

Well said , Dr Rajan!.It is indeed necessary to keep policy making the preserve of the RBI and not allow the tool to monitor it to be with another.
Only thing to be ensured is that policies, howsoever good they are , should be revisited and reviewed periodically to ensure that they have been useful. Sometimes, creative destruction is what is needed .



In Reply to Hemlata Mohan 2 years ago

I'm so comfortable that RBI is in the hand of Mr. Rajan who donot play politics but work for upholiding the integrity of the institution he is heading. Mr. Rajan, we need people like you to talk fearlessly for us.

Companies increasing investment in their own mutual funds

Birla Sun Life MF has over 8% of its assets under management or AUM from investments by group companies followed by HDFC MF at 5%, ICICI Prudential MF at 4.8%, UTI MF at 3.8% and Reliance MF at 3.7%

Leading fund houses have seen a considerable increase in investments in their schemes by their group companies during April-May 2014.


HDFC Mutual Fund (MF), the largest fund house in the country, witnessed 17% rise in investment in its schemes to Rs6,462 crore by group companies during May.


HDFC Mutual Fund was followed by ICICI Prudential MF (16%), Birla Sun Life MF (13%) and Reliance MF (12%).


However, UTI MF saw a drop of 2% in investment in its schemes to Rs3,069 crore by related companies during the first two months of FY15.


Moreover, in April, the top five fund houses saw an increase in investments in the range of 13% and 60%.


In absolute terms, Birla Sun Life MF saw an investment of Rs8,072 crore from its related entities in May, ICICI MF (Rs5,749 crore) and Reliance MF (Rs4,118 crore) were the next two.


Overall, Birla Sun Life MF has over 8% of its assets under management (AUM) from investments by group companies, followed by HDFC MF (5%), ICICI Prudential MF (4.8%) UTI MF (3.8%) and Reliance MF (3.7%).


The fund houses have been disclosing the exact amount of investments by their group companies in their respective schemes following the directive from market regulator Securities and Exchange Board of India (SEBI).


As per SEBI's direction, MFs are required to make monthly disclosure of AUM from different categories of schemes, AUM from places beyond top-15 cities, contribution of sponsor and its associates in AUM, and contribution from different types of investors like retail or corporate.


The fund houses also need to make disclosures about state-wise contribution and AUM from sponsor group or non-sponsor group distributors on their websites and share the same with AMFI within seven working days from end of the month. These rules came into effect from this month onwards.


The norms were recently framed by the market regulator as part of its first-ever long-term policy for the mutual fund industry.



Sankar Amburkar

2 years ago

What does this mean to the retail investor? Does it signify the confidence the group is having on the mutual funds or pushing more money to a venture for revivial?


2 years ago

By the AMCs, of the AMCs, for the AMCs . . .

Supreme court vacates stay on Jayalalithaa's trial

Tamil Nadu Chief Minister, Jayalalithaa faces charges of accumulation of over Rs66 crore worth of assets disproportionate to her known sources of income

The Supreme Court on Tuesday vacated the stay on trial proceedings against Tamil Nadu Chief Minister J Jayalalithaa in the disproportionate assets case against her.


A Bench of Justices Vikramajit Sen and SK Singh also dismissed Jayalalithaa’s petition for staying her trial till the lower court decides the plea of a company, alleging that some of the properties shown as part of the disproportionate assets of the Tamil Nadu chief minister, actually belonged to them.


The apex court recalled its earlier order by which the trial against her was stayed.


The disproportionate assets case was shifted to Bangalore in 2003 following a Supreme Court directive on a petition alleging that a fair trial was not possible in Chennai during her tenure as Chief Minister then.


Jayalalithaa faces charges of accumulation of over Rs66 crore worth of assets disproportionate to her known sources of income.


Besides Jayalalithaa, VK Sasikala, VN Sudhakaran and J Illavarasi are also facing trial in the case.


The Chief Minister had sought a stay on the trial till the lower court decides the plea of Lex Property Development (P) Ltd, a Chennai-based company.


The company had claimed that the properties, which have been attached by the authorities as ‘benami’ holdings of Jayalalithaa, in fact, belonged to it and said this plea be decided first before the lower court proceeds with the trial in the assets case.


The court had allowed the company, which has separately challenged the attachment of properties, to cross examine the witnesses.


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