Column : Towards better financial regulation

Oct 02 2012, 02:06 IST
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SummaryThe current financial regulatory system is inadequate to deal with India’s increasingly complex financial needs.

The Financial Sector Legislative Reforms Commission was set up to review, simplify and rewrite the legislations affecting financial markets in India. It has been asked to make legislations to bring them in tune with the changing financial landscape in India and the world. The commission, headed by former Supreme Court Judge Justice Srikrishna, has been deliberating since April 2011, and consulting with a spectrum of experts and stakeholders in the financial sector and regulators.

The commission has just released an approach paper available on its website (http://www.fslrc.org.in/files/fslrc_approach_paper.pdf). The paper outlines its strategy and the recommendations it is thinking of making in its report to be submitted by end March 2013. The approach emphasises the objectives of regulation, the rule-making process, and discusses a change in India’s financial regulatory architecture.

In the 2000s, through a number of government committee reports such as the Raghuram Rajan and the Percy Mistry reports which highlighted problems in the Indian financial sector, a slow consensus was seen to be developing in support of reforms. As India grows, the needs of the economy for finance increases. Households and firms, especially small firms, do not have access to finance. Until now, the approach in Indian finance has been to give permissions for some products or markets. The rest of the financial products and markets for which no explicit permission is given, are banned. This approach has restricted innovation in financial markets.

The modern approach to financial regulation, in many advanced economies such as Australia and Canada, which have undertaken financial sector reform in recent decades and which were resilient during the crisis, is one which allows greater innovation, and yet addresses issues of market failure in finance, emphasises the objectives of regulation. It emphasises that the objective of regulation is to protect consumers. Protecting consumers can be achieved by creating a system in which it is difficult to cheat them, indulge in unfair practices, or sell them unsuitable products. If this is the objective of the regulator, and he is empowered with instruments to ensure it, he does not prevent innovation as long as the financial firm is not engaged in such practices which violate these objectives. This envisages that the regulator’s objectives are clearly defined, his powers are clearly enumerated and that his decisions are appealable.

With the objective of protecting consumers, the financial regulator must reduce the probability of failure of financial firms. Here, the regulator must not prevent

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