What is regulation for?

The approach paper of the Financial Sector Legislative Reforms Commission (FSLRC) has proposed a new direction for financial regulation in India. While on one hand, half the Indian population still does not have access to finance, on the other, regulations have restricted the growth of financial services. In a country growing at such a rapid pace that the GDP doubles every 8 to 10 years, the needs of people and firms are constantly changing. In recent years, various government committees have pointed to the need for policy change. But it was found that the required changes could not be made under the existing, mostly outdated, financial laws. This prompted a review of the financial legislative framework.

The FSLRC was given the job of reviewing, simplifying and modernising the legislation that affects financial markets in India. It was asked to prepare legislation in tune with the present-day needs of finance. The commission has recently released an approach paper available on its website (http://goo.gl/aJlCQ). The paper discusses its strategy and philosophy.

News reports about the commission have focused on the FSLRC recommendations for India's financial regulatory architecture. But that is only one of the many aspects of Indian finance that the commission was mandated to review. In its proposed recommendations, it has endorsed a transition to a modern regulatory architecture recommended by previous government reports such as the Raghuram Rajan and the Percy Mistry committee reports. These reports had described the problems in the Indian financial sector arising from regulatory cracks and overlaps. The novel element of the FSLRC approach is the emphasis on the modes of independence, accountability and the rule-making process of regulators in India.

The modern approach to financial regulation allows greater innovation. It emphasises the objectives of regulation. Regulation is needed when markets fail. The approach emphasises that the objective of regulation is to protect consumers. This can be achieved by creating a system in which it is difficult to indulge in unfair practices or sell consumers products that are unsuitable for their specific needs. Unlike in goods and services, where there may only be a small lag between payment and delivery, the lags in finance are long and often contingent on a state of nature. A customer keeps paying a premium to buy a promise from an insurance company to pay his family if he dies. The customer does not know if the company is taking on so much risk that when the time to pay comes, it will be bankrupt. It is the job of the regulator to protect him from fraudulent practices and prevent the company from taking on too much risk.

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