Government of India Volume I: Analysis and Recommendations

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EXECUTIVE SUMMARY to analyse one consumer, one financial product, one financial market or one financial firm at a time. The essence of the systemic risk perspective to look at the financial system as a whole. This differs from the perspective of any one financial regulatory agency, and particularly divergent from the perspective of any one sectoral regulator which is likely to see that sector and not the overall financial system. To some extent, systemic crises are the manifestation of failures on the core tasks of financial regulation, i.e. consumer protection, micro-prudential regulation and resolution. If the three pillars of financial regulation would work well, many of the crises of the past, and hypothetical crisis scenarios of the future, would be defused. Systemic risk in India will go down if institutional capacity is built for the problems of consumer protection, micro-prudential regulation and resolution. However, it will not be eliminated. First, despite the best intentions, errors of constructing the institutional framework, and human errors, will take place. Second, even if all three pillars work perfectly, some systemic crises would not be forestalled. This calls for work in the field of systemic risk, as a fourth pillar of financial regulation. While there is a clear case for establishing institutional capacity in these areas, it is also important to be specific in the drafting of law. Unless systemic risk regulation is envisioned as a precise set of steps that would be performed by Government agencies, there is the danger that systemic risk law degenerates into vaguely specified sweeping powers with lack of clarity of objectives. The Commission deeply analysed the problem of reducing the probability of a breakdown of the financial system. This requires understanding the financial system as a whole, as opposed to individual sectors or firms, and undertaking actions which reduce the possibility of a collapse of the financial system. Each financial regulator tends to focus on regulating and supervising some components of the financial system. With sectoral regulation, financial regulators sometimes share the worldview of their regulated entities. What is of essence in the field of systemic risk is avoiding the worldview of any one sector, and understanding the overall financial system. In order to achieve this, Commission envisages a five-part process. The first step is the construction and analysis of a system-wide database. This effort, which will be located at the Financial Stability and Development Council (Financial Stability and Development Council (FSDC)), will analyse the entire financial system and not a subset of it. The discussions at FSDC would communicate the results of this analysis to all regulators, who would co-operate in proposing and implementing solutions. The second step is the identification of Systemically Important Financial Institutions (SIFIs). The analysis of the unified database, using rules which are agreed upon at FSDC, will be used to make a checklist of SIFIs. These will be subjected to heightened microprudential regulation by their respective supervisors. The third step is the construction and application of system-wide tools for systemic risk regulation. The fourth step is inter-regulatory co-ordination. Effective co-ordination across a wide array of policy questions is an essential tool for systemic risk reduction. Finally, the fifth step is crisis management. The Commission envisages the Ministry of Finance as playing the leadership role in a crisis. Here, FSDC will only play a supporting role. Four of the five elements of the systemic risk process involve a leadership role at FSDC. The Commission envisages that FSDC would be a new statutory agency, in contrast with its relatively informal existence at present. xxii FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION
EXECUTIVE SUMMARY Financial inclusion and market development The development agenda in Indian financial economic policy comprises two elements: (i) The development of market infrastructure and processes, and (ii) Redistribution and financial inclusion initiatives, where certain sectors, income or occupational categories are the beneficiaries. The framework proposed by the Commission involves placing the first objective with regulators and the second with the Government. The draft Code envisages regulators undertaking initiatives in the first area. For the second area, the Government would issue notifications in the Gazette, instructing regulators to impose certain requirements upon stated financial firms. The Government would be obliged to make payments to firms to reflect the costs borne by them. The Commission felt that all initiatives of this nature – in the pursuit of inclusion or of development – should be subject to systematic evaluation after a period of three years. Decision making would be improved by a process of articulation of specific goals, followed by an evaluation of the extent to which these goals were met. Monetary policy The framework envisaged by the Commission features a strong combination of independence and accountability for RBI in its conduct of monetary policy. The first stage lies in defining the objective of monetary policy. The Ministry of Finance would put out a Statement defining a quantitative monitorable ‘predominant’ target. Additional, subsidiary targets could also be specified, which would be pursued when there are no difficulties in meeting the predominant target. The draft Code places an array of powers with RBI in the pursuit of this objective. Decisions on the use of these powers would be taken at an executive Monetary Policy Committee (MPC). The MPC would meet regularly, and vote on the exercise of these powers, based on forecasts about the economy and the extent to which the objectives are likely to be met. The MPC would operate under conditions of high transparency, thus ensuring that the economy at large has a good sense about how the central bank responds to future events. Alongside this core monetary policy function, RBI would operate a real time gross settlement system, that would be used by banks and clearing houses. It would also operate mechanisms for liquidity assistance through which certain financial firms would be able to obtain credit against collateral. Public debt management agency The management of public debt requires a specialised investment banking capability for two reasons: 1. Debt management requires an integrated picture of all onshore and offshore liabilities of the Government. At present, this information is fragmented across RBI and the Ministry of Finance. Unifying this information, and the related debt management functions, will yield better decisions and thus improved debt management. 2. A central bank that sells government bonds faces conflicting objectives. When RBI is given the objective of obtaining low cost financing for the Government, this may give RBI a bias in favour of low interest rates which could interfere with the goal of price stability. In its entirety, the problem of debt management for the Government includes the tasks of cash management and an overall picture of the contingent liabilities of the Government. These functions are integrated into a single agency through the draft Code. FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION xxiii
Page 1: Government of India _______________
Page 5 and 6: Contents Acronyms . . . . . . . . .
Page 7: CONTENTS 12 Public debt management
Page 10 and 11: ACRONYMS FSAT Financial Sector Appe
Page 13 and 14: Acknowledgement When the Ministry o
Page 15: ACKNOWLEDGEMENT appreciate the effo
Page 18 and 19: EXECUTIVE SUMMARY rience till date.
Page 20 and 21: EXECUTIVE SUMMARY out many processe
Page 22 and 23: EXECUTIVE SUMMARY can issue regulat
Page 24 and 25: EXECUTIVE SUMMARY Alongside this, i
Page 28 and 29: Contracts, trading and market abuse
Page 30 and 31: 5. A new Financial Redressal Agency
Page 32 and 33: EXECUTIVE SUMMARY States GDP as of
Page 34 and 35: 1.2. Deliberations in the Commissio
Page 36 and 37: INTRODUCTION amendments frequently
Page 38 and 39: INTRODUCTION sectoral composition o
Page 40 and 41: INTRODUCTION The Commission has und
Page 43 and 44: CHAPTER 2 The tasks of financial la
Page 45 and 46: THE TASKS OF FINANCIAL LAW This is
Page 47 and 48: THE TASKS OF FINANCIAL LAW ◮ “i
Page 49 and 50: THE TASKS OF FINANCIAL LAW 2.5. Own
Page 51 and 52: THE TASKS OF FINANCIAL LAW desirabl
Page 53 and 54: CHAPTER 3 Structure of the regulato
Page 55 and 56: STRUCTURE OF THE REGULATOR Table of
Page 61 and 62: CHAPTER 4 Functions and powers of t
Page 63 and 64: FUNCTIONS AND POWERS OF THE REGULAT
Page 73: FUNCTIONS AND POWERS OF THE REGULAT
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CONSUMER PROTECTION The consumer pr
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Table of Recommendations 5.4 Princi
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CONSUMER PROTECTION using or disclo
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CONSUMER PROTECTION providers. The
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CONSUMER PROTECTION Table of Recomm
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CHAPTER 6 Micro-prudential regulati
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MICRO-PRUDENTIAL REGULATION let tha
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MICRO-PRUDENTIAL REGULATION Table o
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MICRO-PRUDENTIAL REGULATION PRINCIP
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MICRO-PRUDENTIAL REGULATION the oth
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RESOLUTION payment systems. The cor
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RESOLUTION Commensurately, the corp
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Table of Recommendations 7.3 Intera
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Table of Recommendations 7.5 Powers
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Table of Recommendations 7.7 Fundin
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CHAPTER 8 Capital controls Capital
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CAPITAL CONTROLS 2. Absence of judi
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CAPITAL CONTROLS Table of Recommend
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CAPITAL CONTROLS Table of Recommend
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Table of Recommendations 9.1 Object
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Table of Recommendations 9.3 Establ
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SYSTEMIC RISK filings by financial
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SYSTEMIC RISK Table of Recommendati
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egulatory agencies. In such a situa
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FINANCIAL INCLUSION AND MARKET DEVE
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FINANCIAL INCLUSION AND MARKET DEVE
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Table of Recommendations 11.1 Objec
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Table of Recommendations 11.2 The m
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Table of Recommendations 11.3 Board
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CHAPTER 12 Public debt management 1
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PUBLIC DEBT MANAGEMENT of the publi
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PUBLIC DEBT MANAGEMENT State Govern
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PUBLIC DEBT MANAGEMENT Table of Rec
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CHAPTER 13 Foundations of contracts
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FOUNDATIONS OF CONTRACTS AND PROPER
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14.2. Problems of the present arran
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FINANCIAL REGULATORY ARCHITECTURE T
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FINANCIAL REGULATORY ARCHITECTURE w
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TRANSITION ISSUES On the functional
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TRANSITION ISSUES service providers
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SUMMARY OF RECOMMENDATIONS NOT EMBE
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CHAPTER 17 Conclusion Financial eco
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18.2. Note of dissent by K.J. Udesh
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18.3. Note of dissent by P.J. Nayak
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NOTES OF DISSENT A second difficult
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NOTES OF DISSENT 6. The present arr
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CHAPTER 19 Annexes 19.1. Formation
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ANNEXES 19.2. List of consultants,
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ANNEXES * Did not participate in th
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ANNEXES 19.5. Interactions with aut
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ANNEXES (c) Examine whether informa
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ANNEXES 2. General development of m
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ANNEXES 19. Role of surveyors: (a)
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ANNEXES 6. The law must provide for
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ANNEXES 31. Resolution of insurance
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ANNEXES 3. As shocks can spread thr
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ANNEXES 19.8.2. Terms of Reference
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ANNEXES (d) The Board of the target
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ANNEXES 2. The PDMA should adopt a
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ANNEXES 3. On the issue of co-opera
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ANNEXES 14. Regulators must look at
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ANNEXES 31. The WG recommends the m
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ANNEXES (b) Efficiency of DRT: Suit
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ANNEXES (c) Pledged shares and exem
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ANNEXES 19.11. Interactions by the
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ANNEXES 19.13. Submissions to FSLRC
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Government of India Volume I: Analysis and Recommendations

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