Government of India Volume I: Analysis and Recommendations

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MICRO-PRUDENTIAL REGULATION of offshore trading venues deny users of markets the lowest cost products and services. Conversely, a regulatory race to the bottom where economic stability is sacrificed to increase competitiveness is equally problematic. PRINCIPLE 7. The need to take into account the long term implications of regulatory actions, which will include a period of at least five years following a regulatory action. Numerous examples illustrate how micro-prudential regulation can be used in a manner that reduces failure over a short period of time, though with much worse consequences over a longer period of time. For example, regulations that allow conversion of a pool of illiquid, poorly rated assets into liquid tranches of differentially rated securities (some of them highly rated), may reduce the total capital obligations for the institutions originating these assets, while also seeming to maintain safety and soundness. Such regulation, if not conducted properly with sound alignment of incentives, requirement of buffers at different levels, and other checks and balances, may encourage creation of risks that may have consequences years later, perhaps going beyond the regulatory cycle in which the regulation was notified. PRINCIPLE 8. The need to minimise the pro-cyclical effects of regulatory actions. Micro-prudential regulation can often be pro-cyclical, that is, it can amplify business cycle fluctuations, and possibly cause or exacerbate financial instability. In a contraction, regulatory constraints may bite well before the bankruptcy law does, as financial institutions regard violating minimum capital requirements as extremely costly. Depending on how the instruments of micro-prudential regulation are used, the extent of pro-cyclicality may vary. In the framework proposed by the Commission, the primary function of micro-prudential regulation is to think about one financial firm at a time. The task of thinking about overall systemic risk has been placed separately from micro-prudential regulation, precisely because micro-prudential regulation requires a different perspective. This principle requires micro-prudential regulators to be aware of the extent to which their rules are pro-cyclical and to seek alternative mechanisms which minimise this phenomenon. PRINCIPLE 9. The requirement that persons who control and manage the affairs of regulated persons must share the responsibility of ensuring the safety and soundness of the regulated persons. Though the main objective of micro-prudential regulation is to maintain safety and soundness for regulated persons, the regulator is not the one ultimately responsible for the safety and soundness of the regulated persons. That responsibility should stay with the board and management of the regulated person. Once a financial service provider is identified for micro-prudential regulation, consumers, investors and other stake-holders should not perceive themselves to be absolved from responsibility for the safety and soundness of that institution. Regulation is only an additional set of measures that do not replace the efforts of the board and management of the regulated person. The regulator should lay out frameworks, which the board and management would be responsible for implementing. In addition to these principles enshrined in the draft Code, the Commission also recommends that micro-prudential regulation be conducted in such a manner that there is balance between a structured and a responsive regulatory approach. A very structured, rules-based approach may bring clarity and certainty for regulated institutions, but may limit the ability of the regulator to see risks arising from areas they may not have thought about sufficiently in time. Also, if an institution is able to find a way to game the rules, the regulator may not be able to see the problems at all. Regulators could miss the big picture while being overly dependent on minutiae of the framework they have put in place. On 66 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION
MICRO-PRUDENTIAL REGULATION the other hand, a principles-based, more discretionary approach may reduce certainty for the regulated institutions but give the regulator greater flexibility to pursue the microprudential objective. A balance needs to be struck between these two possibilities. While there is merit in having primarily a structured approach to regulation, the nature of micro-prudential regulation is such that the regulator should not get overly dependent on a structured framework and specific rules, and should have capabilities to scope and monitor the risks being built, and through due process, respond to these risks pro-actively. This requires a mix of rules and judgement. FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 67
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Government of India _______________
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Contents Acronyms . . . . . . . . .
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CONTENTS 12 Public debt management
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ACRONYMS FSAT Financial Sector Appe
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Acknowledgement When the Ministry o
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ACKNOWLEDGEMENT appreciate the effo
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EXECUTIVE SUMMARY rience till date.
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EXECUTIVE SUMMARY out many processe
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EXECUTIVE SUMMARY can issue regulat
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EXECUTIVE SUMMARY Alongside this, i
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EXECUTIVE SUMMARY to analyse one co
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Contracts, trading and market abuse
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5. A new Financial Redressal Agency
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EXECUTIVE SUMMARY States GDP as of
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1.2. Deliberations in the Commissio
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INTRODUCTION amendments frequently
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INTRODUCTION sectoral composition o
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INTRODUCTION The Commission has und
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CHAPTER 2 The tasks of financial la
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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
Page 76 and 77: CONSUMER PROTECTION The consumer pr
Page 78 and 79: Table of Recommendations 5.4 Princi
Page 80 and 81: CONSUMER PROTECTION using or disclo
Page 82 and 83: CONSUMER PROTECTION providers. The
Page 84 and 85: CONSUMER PROTECTION Table of Recomm
Page 87 and 88: CHAPTER 6 Micro-prudential regulati
Page 89 and 90: MICRO-PRUDENTIAL REGULATION let tha
Page 91 and 92: MICRO-PRUDENTIAL REGULATION Table o
Page 97: MICRO-PRUDENTIAL REGULATION PRINCIP
Page 102 and 103: RESOLUTION payment systems. The cor
Page 104 and 105: RESOLUTION Commensurately, the corp
Page 106 and 107: Table of Recommendations 7.3 Intera
Page 108 and 109: Table of Recommendations 7.5 Powers
Page 110 and 111: Table of Recommendations 7.7 Fundin
Page 113 and 114: CHAPTER 8 Capital controls Capital
Page 115 and 116: CAPITAL CONTROLS 2. Absence of judi
Page 117 and 118: CAPITAL CONTROLS Table of Recommend
Page 119: CAPITAL CONTROLS Table of Recommend
Page 122 and 123: Table of Recommendations 9.1 Object
Page 124 and 125: Table of Recommendations 9.3 Establ
Page 126 and 127: SYSTEMIC RISK filings by financial
Page 128 and 129: SYSTEMIC RISK Table of Recommendati
Page 130 and 131: egulatory agencies. In such a situa
Page 132 and 133: FINANCIAL INCLUSION AND MARKET DEVE
Page 134 and 135: FINANCIAL INCLUSION AND MARKET DEVE
Page 136 and 137: Table of Recommendations 11.1 Objec
Page 138 and 139: Table of Recommendations 11.2 The m
Page 140 and 141: Table of Recommendations 11.3 Board
Page 143 and 144: CHAPTER 12 Public debt management 1
Page 145 and 146: PUBLIC DEBT MANAGEMENT of the publi
Page 147 and 148: 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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