Government of India Volume I: Analysis and Recommendations

FINANCIAL INCLUSION AND MARKET DEVELOPMENT
Market development requires information gathering and analysis, which may be at
the level of one sector, or on the scale of the full financial system. Inter-regulatory coordination
is often called for. Market development may also require spending resources
on market infrastructure that has public good characteristics. Such resources may be recovered
from the financial service providers, and spent on market infrastructure based on
a thorough understanding of costs and benefits. Market development may also require
notifying regulations to bring market processes in line with international best practices.
Accordingly, the Commission, after much debate on the objectives of regulators in
the pursuit of development, recommends that the regulatory objective of development
should translate into the following:
1. Modernisation: The regulator should undertake measures that are necessary to modernise market
infrastructure or market process, particularly measures with regard to the adoption of new
technology.
2. Enlarging consumer participation: The regulator should be able to pursue certain social goals
which contribute to the welfare of the people more broadly. In particular, the regulator should be
able to undertake measures that provide for the differentiation of financial products or financial
services to specified categories of consumers, or that enlarge consumer participation in financial
markets generally.
3. Best practices: The regulator may undertake measures to align market infrastructure or market
process with international best practices.
Besides the measures that the regulator may undertake to pursue its objective of
market development, the Commission recommends that the Central Government should
be able to direct a specific regulator to ensure the provision of specified financial services
by specified financial service providers or to any consumer or class of consumers. The
provision of services in this regard must be with a view to ensure effective and affordable
access of financial services to persons who would ordinarily not have such access.
The Commission acknowledges that there may be costs incurred by financial service
providers in implementing such directions, and recommends that the Central Government
reimburse the cost of granting such access to the financial service providers.
10.2. Institutional architecture
The Commission believes that these questions of development of markets and financial
inclusion create certain problems for public administration. As an example, consider an
attempt at subsidising credit for agriculture, or an attempt at increasing the flow of credit
into certain states. If this is done by a financial regulator, three problems are encountered:
1. Hidden costs: When a regulation forces banks to give more loans to open a bank branch in a nonprofitable
location, this imposes a cost – a tax – upon other branches, and also depositors and
shareholders. Questions of institutional design are raised when the power to impose such costs
on certain parts in society is given to unelected officials. Therefore, the Commission recommends
that where there is a cost incurred by financial service providers in granting effective and affordable
access to financial services, such financial service providers should be reimbursed in some
form (for example, cash, cash equivalents or tax benefits).
2. Dilution of accountability: There is considerable policy knowledge and experience worldwide
about embedding principles of accountability into systems of consumer protection and microprudential
regulation. There is less experience and information available with regard to accountability
principles for market development or inclusion initiatives. For example, the number of
households that participate in a given financial product may be increased quickly by reducing the
burden of consumer protection. Similarly, the function of redistribution to exporters, by requiring
banks to give loans to exporters, is in direct conflict with the function of protecting consumers
who deposit money with banks. Competing objectives can hinder accountability.
3. Inefficiency: When a transfer is achieved by taxing some consumers in order to deliver gains to
others, this is a form of taxation. The Commission believes such implicit and selective taxation of
different categories of consumers is inefficient.
100 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION