Government of India Volume I: Analysis and Recommendations

THE TASKS OF FINANCIAL LAW
This is a superior approach from many points of view. Shifting away from sectoral
laws yields consistent treatment across sectors. It has become increasingly clear that the
lines that separate banking or insurance or mutual funds or pension fund management
are hard to define. Under this situation, if sectoral laws are applied, regulatory arbitrage
becomes feasible, where the same activity is portrayed as belonging in the sector where
the law is conducive to a higher profit rate. Non-sectoral laws that apply uniformly across
the financial system eliminate such inconsistencies of treatment. They also eliminate the
problems of gaps and overlaps.
While the draft Code proposed by the Commission is non-sectoral in nature, it is
likely that regulators will draft sector-specific subordinated legislation. For example, the
principles of consumer protection, embedded in the consumer protection part of the
draft Code, will be translated by multiple regulatory bodies into detailed regulations that
shape how consumers of banking or insurance are treated. The subordinated rules and
regulations will, however, have to be consistent with the broad principles laid down in
the primary law.
As an example, the term NBFC in India includes a wide array of activities. Rational
and consistent treatment of a broad class of firms requires a clear conceptual framework.
The approach taken by the Commission emphasises that regulation should flow
from the economic and legal concern that the law seeks to address. It is useful to focus
on the regulatory concerns associated with the main NBFC activities: deposit-taking, raising
capital through securities issuance, and lending to consumers and investment. Under
the framework proposed by the Commission, all these activities would be analysed
through the objectives and powers contained in the draft Code under the parts on microprudential
regulation, consumer protection and resolution. As an example, when a NBFC
gives a loan to a consumer, the regulatory focus would be on consumer protection. If a
NBFC does not take deposits, the nature of promises made to consumers changes, and
the micro-prudential regulatory strategy would be correspondingly different.
In this fashion, conceptual clarity about the purpose of regulation would help regulators
understand the diverse array of financial firms and activities, and apply the suitable
regulatory instruments to each situation.
2.2. Adopting a principles-based approach
The Commission believes that there is value in harnessing India’s common law tradition,
where laws enacted by Parliament work at the level of high principles, and do not embed
specific details. These relatively timeless principles are linked to the continuously
evolving world of technology, institutional arrangements and financial sector processes
through two methods: continuous revision of subordinated legislation that is drafted by
the regulator, and interpretation by the judiciary. This approach, which may be termed
an Occam’s razor applied to the field of law, has worked well with components of Indian
law such as the Evidence Act and the Contract Act, both of which were enacted in 1872,
and have largely stood the test of time.
In the field of finance, this implies a ‘principles-based’ approach. Laws will articulate
broad principles that do not vary with financial or technological innovation. Regulators
will write subordinated legislation that could either be in the form of detailed prescriptive
rules or be principles-based, depending on the situation and the judgment of the regulator.
Subordinated legislation will be frequently modified by regulators, through a process
defined by Parliament, and thus constantly adapt to financial and technological innovation.
This combination of legislation and subordinated legislation yields a body of law
that evolves smoothly over time. For a contrast, if detailed features of financial products
FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 13