Fixing the foundations

Chit fund scams shine the light on the need to overhaul the financial regulatory architecture

Cases of semi-regulated or unregulated entities making unrealistic promises to consumers are roiling the financial landscape. It is high time the government sees the pattern and undertakes fundamental change. The search for a solution must factor in two realities. The first is the failure of the formal regulated financial system. The breakdown of present policy frameworks in finance has resulted in a stunted system. For most households, formal finance does not exist. Informal or unregulated or illegal finance has sprung up wherever there are gaps in access. Socialist policies in finance, supposedly in the name of the poor, have ended up depriving households of the access to finance and driven them into the arms of unregulated finance.

The second culprit is financial law. Existing laws do not clearly require regulators to identify and block malfeasance. In addition, the existing laws have set up an improbable mess of financial regulatory agencies where there is a lack of clarity about what must be done and by whom. The bureaucrats who run these agencies have the unenviable task of trying to work within a legal mess. They are busy squabbling, avoiding responsibility, defending or extending turf. Without accountability mechanisms, agencies like the RBI or SEBI or IRDA have no pressure to deliver results and are only focused on gaining powers and turf. The recent scandals prove that the present regulatory framework in which the RBI is expected to regulate non-banking financial companies has completely failed.

Fixing the broken financial regulatory framework should be the top priority of Parliament. The solution lies in fundamental change, both in the legal foundations and in the financial regulatory architecture. The Indian Financial Code, drafted by the Financial Sector Legislative Reforms Commission, addresses both problems. It lays the foundation for a sensibly regulated financial system. It has a work allocation that avoids gaps and overlaps. It defines financial services. Within that, banking and payments is assigned to the RBI, and all other financial activities are with the Unified Financial Agency. This eliminates regulatory gaps, and offers clarity about who is in charge. The code lays down the four tasks of financial regulation: protecting consumers, reducing the probability of failure of financial firms, gracefully closing down distressed financial firms and the redress of grievance. The ministry of finance needs to embark on a plan to implement the code, and in the process, recast the financial regulatory architecture.

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