Government of India Volume I: Analysis and Recommendations

14.2. Problems of the present arrangements
FINANCIAL REGULATORY ARCHITECTURE
At present, India has a legacy financial regulatory architecture. The present work allocation
– between RBI, SEBI, IRDA, PFRDA, and FMC – was not designed; it evolved over the
years, with a sequence of piecemeal decisions responding to immediate pressures from
time to time.
The present arrangement has gaps for which no regulator is in charge – such as the
diverse kinds of ponzi schemes that periodically surface in India, which are not regulated
by any of the existing agencies. It also contains overlaps where conflicts between regulators
has consumed the energy of top economic policy makers and held back market
development.
Over the years, these problems will be exacerbated through technological and financial
innovation. Financial firms will harness innovation to place their activities into the
gaps, so as to avoid regulation. When there are overlaps, financial firms will undertake
forum-shopping, where the most lenient regulator is chosen, and portray their activities
as belonging to that favoured jurisdiction.
An approach of multiple sectoral regulators that construct ‘silos’ induces economic
inefficiency. At present, many activities that naturally sit together in one financial firm are
forcibly spread across multiple financial firms, in order to suit the contours of the Indian
financial regulatory architecture. Financial regulatory architecture should be conducive
to greater economies of scale and scope in the financial system. In addition, when the
true activities of a financial firm are split across many entities, each of which has oversight
of a different supervisor, no single supervisor has a full picture of the risks that are present.
Fragmentation of financial firms, which responds to fragmentation of financial regulation,
leads to a reduced ability to understand risk.
When a regulator focuses on one sector, certain unique problems of public administration
tend to arise. Assisted by lobbying of financial firms, the regulator tends to share
the aspirations of the regulated financial firms, such as low competition, preventing financial
innovation in other sectors, high profitability, and high growth. These objectives
often conflict with the core economic goals of financial regulation such as consumer protection
and swift resolution.
Reflecting these difficulties, the present Indian financial regulatory architecture has,
over the years, been universally criticised by all expert committee reports. The Commission
has analysed the recommendations for reform of financial regulatory architecture
of all these expert committee reports and weighed the arguments presented by each of
them.
14.3. Considerations that guide alternative architecture
choices
In order to analyse alternative proposals in financial regulatory architecture, the Commission
established the following principles:
Accountability: Accountability is best achieved when an agency has a clear purpose.
The traditional Indian notion that a regulator has powers over a sector but lacks
specific objectives and accountability mechanisms is unsatisfactory.
Conflicts of interest: In particular, direct conflicts of interest are harmful for accountability
and must be avoided.
A complete picture of firms: A financial regulatory architecture that enables a comprehensive
view of complex multi-product firms, and thus a full understanding of the risks
that they take, is desirable.
132 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION