Government of India Volume I: Analysis and Recommendations

Table of Recommendations 9.1 Objectives
SYSTEMIC RISK
The Commission notes that even if individual institutions appear sound and are well-monitored, system-wide risks
may build up in the aggregate. Such risks need to be monitored, identified and addressed - with a system-wide
perspective and not a sectoral perspective. Hence there is a need for an agency to:
1. Foster the stability and resilience of the financial system by identifying, monitoring and mitigating systemic
risk; and
2. Improve co-ordination between multiple regulatory agencies (such as the micro-prudential regulators, the
resolution corporation and other agencies within the financial system) by bringing diverse perspectives into
the discussion, engaging with the regulatory stake-holders, identifying and reducing regulatory uncertainty
(including regulatory arbitrage), and addressing unregulated areas.When a systemic crisis materialises, the
agency must assist the Ministry of Finance and regulatory agencies in their efforts relating to resolving the
crisis.
Many of the crises of the past, and hypothetical crisis scenarios of the future, are indictments
of the limits of such regulation, standing alone. Increasing institutional capacity to
address the problems of consumer protection, micro-prudential regulation and resolution
will certainly work to diminish systemic risk, however, such risk will not be eliminated.
The Commission notes that despite well-intentioned implementation, flaws in institutional
design, and errors of operation in existing institutional arrangements are inevitable.
Additionally, even if extant consumer protection, micro-prudential regulation
and resolution regimes work perfectly, some systemic crises may not be prevented, and
measures to contain such crises will need to be developed. These dimensions of concern
call for urgent and thorough work in the field of systemic risk oversight, as a fourth pillar
of financial regulation.
9.2. Objectives and principles
While there is a clear case for establishing institutional capacity in these areas, it is also
important to be specific in the enunciation of its implementation. Unless systemic risk
regulation is envisioned as a precise set of functions, demarcated by clear and concrete
rules as specified by the draft Code, systemic risk law could easily devolve into a set of
vaguely specified sweeping powers, and there could be a danger of sacrificing the goals
of development and efficiency in favour of avoiding potential systemic risk. Therefore,
the Commission has taken care to precisely articulate the strategy for systemic risk oversight,
seeking to avoid any draconian control of regulatory powers and emphasising on
inter-regulatory agency co-ordination. The Commission’s recommendations also emphasise
broad principles of regulatory governance so as to ensure that the operations
of an agency charged with such functions are guided by an appropriate set of checks and
balances.
Table 9.1 enunciates the objectives of systemic risk oversight.
Table 9.2 lists the principles that should guide the functioning of the agency designated
to monitor and address systemic risk concerns.
9.3. Institutional arrangement
The monitoring of systemic risk across the world, in varying capacities, has resulted in
countries adopting differing structural frameworks for this purpose. For example, the UK
has envisaged a Financial Policy Committee, located within the Bank of England, that
functions in a manner analogous to its Monetary Policy Committee. The US has established
a statutory body called the Financial Stability Oversight Council which comprises
the heads of various regulatory agencies and government representatives. Similarly, the
90 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION