Indian Financial Code

Our economy has, in the recent years, been dogged by low-growth, corruption and a general lack of investor/consumer confidence. With the recent elections bringing about a change in governments, new and inspiring leadership has indicated a positive future for India once again by laying out measures to revive our economy, including reducing inflation, enhancing production and output, maintaining healthy for-ex reserves and narrowing the current and fiscal deficits, among others.

The Indian financial sector is an important part of India’s growth story and deserves strong focus so as to ensure it can handle the test of time as our economy engines on towards becoming an economic powerhouse. The financial crisis of 2008, felt so acutely in developed countries like U.S., Europe etc., taught us the importance of good governance and regulations in the finance sector.

Recognising the need for a review of the Indian financial system way back in 2009, the government eventually set up the FSLRC (Finance Sector Legislative Reforms Commission) who came out with their report in March 2013.. Their study on the legislations/framework governing financial processes and institutions in our country threw up issues concerning gaps and inconsistencies in regulations, presence of arbitrage and overlaps in the functioning of regulatory bodies.

Recommendations of the FSLRC:

- To bring different regulatory bodies under the ambit of one regulator by setting up a UFA or United Financial Agency.

The idea is to merge the major regulators SEBI, IRDA, FMC and PFRDA. Currently, we have sector-specific regulatory bodies e.g. the insurance sector has the IRDA (Insurance Regulatory and Development Authority), the equity markets have SEBI (Securities and Exchange Board of India), the commodities derivatives market has the FMC (Forward Markets Commission), national pension schemes are governed by the PFRDA (Pension Fund Regulatory and Development Authority) etc. These bodies function in a manner that show tendencies to overlap in their regulations. Moreover, these bodies also display the need for restructuring to improve efficiency. A multitude of regulatory authorities within the financial system creates unwanted complexity, making it difficult for the government to address issues related to overall governance and legislation besides crafting long-term plans requiring inter-regulatory cooperation and coordination.

- To narrow the RBI’s (Reserve Bank of India) focus and purview.

The aim is enable the RBI to strengthen the Indian banking system which needs to be broadened for increased financial inclusion.Establishment of new banks and legislation to this effect will be a part of the RBI’s new focus. This move also proposes to take NBFCs (Non-Banking Financial Companies) out of the purview of the RBI. The RBI would also be expected to increase its concentration on the country’s monetary policy which is so crucial to our financial stability. It has been outlined that the RBI will manage all monetary outflows from the country leaving the management of monetary inflows to the government. Another function to be taken out of the hands of the RBI is the management of public debt. It appears to the FSLRC, to be more beneficial, if this function is controlled by a separate agency.

- Financial sector development

This is to be achieved through more micro-prudence and consumer protection. Under the IFC, proposals are in place for the structuring of financial consumer rights. As of now regulations are at a macro level whereas there is a pressing need for more micro-regulations. Especially given the increasing depth of the financial market with the mushrooming of new players and innovative products outpacing the absorption of financial knowledge by lay consumers/investors. For e.g. there are no real mechanisms in place to ascertain that those investing in a particular mutual fund claiming returns of say 10% are actually going to get the benefits promised to them. How does one track the actual investments made by the funds or the appropriation of funds. In the absence of proper legislations or redressal mechanisms many consumers fall prey to mis-selling. Financial institutions try to increase their customer-base with a number of unverified claims especially since accountability is low. The IFC recommends the creation of the FRA or Financial Redressal Agency to address financial consumers’ grievances.

- Prevention is better than cure

When major financial corporations can fall from grace (as witnessed in the financial crisis of 2008), impacting the entire economy, local and global, adversely affecting the interests of its stakeholders, there is a definite need for prevention of financial meltdowns/failures. The IFC hopes to establish the means through which such failing institutions can be identified and move them out of the system through liquidation or any other means that safeguards the interests of its stakeholders especially small investors/customers who are, presently, largely neglected during trying times.The FSLRC is of the opinion that there should be a single agency to monitor systemic risk i.e. the risk arising from an upset caused in the financial system that can have real and negative consequences on the economy. With sector-specific regulatory bodies, there is a need for inter-regulatory coordination to address the risk, which decreases responsiveness in adverse situations. However, this can be simplified with the establishment of an FSDC or Financial Stability and Development Council headed by the Ministry of Finance (MoF). The FSDC will help collate important and meaningful data from the various sectors and identify institutions that are critical to the financial system i.e. those institutions whose failure/success can negatively/positively affect the economy. Besides coming up with risk-adequacy norms, the FSDC will aid the MoF in resolving issues during downturns/crises.

The FSLRC’s recommendations have led to a draft Indian Financial Code. This is being modified for implementation by 2015. However, it is also being met with opposition from within the financial system with regards to some of its features/propositions. With due discussion, revision and modifications where appropriate, the IFC should prove to be a catalyst in propelling the Indian financial system to greater strengths.

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Report of the Financial Sector Legislative Reforms Commission (PDF): http://finmin.nic.in/fslrc/fslrc_report_vol2.pdf