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New foundations of India’s financial transformation

This is a transformative report. It’s not going to be easy to understand the nuances of laws, rules and regulations that it holds. But like it or not, if you are in the financial sector in any capacity — as a politician, a regulator, an academic, a journalist, an executive or agent-advisor and most important, a consumer — the two-volume, 439-page Report of the Financial Sector Legislative Reforms Commission (FSLRC) is a piece of financial literature you can’t afford not to engage with. Among many things and through a quick reading, here’s what I like.

The report has overturned the financial governance pyramid by placing the most important constituent, the consumer, right at the top from the bottom. This consumer-first stance has been backed by granting six basic protections for all consumers — financial service providers to act with professional diligence; protection against unfair contract terms; protection against unfair conduct; protection of personal information; fair disclosure; and redress of complaints. In addition, there are three protections for unsophisticated consumers — right to receive suitable advice; protection from conflicts of interest of advisors; and access to redress agency for grievances. For the record, this is the first time that consumers of financial products have been given ‘protection’ by law. So far, this protection has been on the whims and fancies of regulators — personal, shifting, uneven. Under the FSLRC recommendations, these will be embedded into law.

This is in tune with the report’s shift away from sector-specific regulations to delivering “economic purpose”. A consumer of finance doesn’t care very much whether it’s SEBI or IRDA regulating the company he’s buying a wealth creation product from. Universal banks, by selling conflicting sectoral products — banking and housing finance, or mutual funds and insurance, for instance — under a single brand often end up confusing consumers and misselling products that help bottomlines of banks and advisors rather than future of consumers. In a process that’s designed to deceive, consumers seeking protection end up buying not term cover but an endowment, not a mutual fund but a ULIP. Agents, particularly banks, sit in the regulatory spaces between RBI, SEBI and IRDA. The cost is thrown on the consumer, for whom, ironically, the entire sector has been designed in the first place.

By moving away from sectors like capital markets, insurance and banking into nine areas that dance with what are consumer — and national — needs, the report has virtually reorganised finance. In the new framework, Indian finance will function not sectorally but under nine heads — consumer protection (I like that consumers are on top), micro-prudential regulation, resolution, capital controls, systemic risk, development, monetary policy, public debt management, and foundations of contracts and property. This shift has another advantage: consistent treatment across sectors that help prevent regulatory arbitrage. This arbitrage is not merely in commission structures. The KYC norms that each regulator creates become an entry barrier to various products.

A new Financial Redressal Agency will implement the new regulatory architecture. It will setup a nationwide machinery to become a one stop shop where consumers can carry complaints against all — all — financial firms. That includes banks. In the regulatory space, the biggest impact of this agency will fall on RBI, the big and invisible elephant in any financial discussion and one that revels in status quo, protecting banks rather than consumers, delivering profits to PSU banks over private, financial inclusion over efficiency, and of late, resisting any move towards mobile banking that will give genuine access to the poor.

Politically, the FSLRC recommendations are going to face a steep slope in their implementation — there are going to be 16 Acts of Parliament that will have to be repealed. These are:

1. The Securities Contracts (Regulation) Act, 1956

2. The Securities and Exchange Board of India Act, 1992

3. The Depositories Act, 1996

4. The Public Debt Act, 1944

5. The Government Securities Act, 2006

6. The Reserve Bank of India Act, 1934

7. The Insurance Act, 1938

8. The Banking Regulation Act, 1949

9. The Forward Contracts (Regulation) Act, 1952

10. The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970

11. The Deposit Insurance and Credit Guarantee Corporation Act, 1961

12. The Foreign Exchange Management Act, 1999

13. The Insurance Regulatory and Development Authority Act, 1999

14. The Payment and Settlement Systems Act, 2007

15 and 16. The Acts establishing bodies corporate involved in the financial sector (e.g. The State Bank of India Act, 1955 and The Life Insurance Corporation Act, 1956)

Additionally, there will 50 Acts that will be amended.

With a fractured polity like today’s that’s unlikely to change in the foreseeable future and an extremely low level of interest in financial matters by Parliament, the tug-of-war on the smallest of recommendations could outstretch the report’s reformist stance. The good news: politically, the investment that will go into turning the Indian Financial Code Bill into law will be no different from any other law — parties will vote on issues that have little to do with the Act but on considerations that extend beyond.

Onto specifics, repealing the LIC Act will raise partially-legitimate pseudo-concerns on the fiscal and disinvestment front. Expect cries — ironically, in the name of consumers — from here. And just as LIC does not come under the jurisdiction of IRDA, SBI is not regulated by RBI. If things go according to the recommendations, both these companies will come under the Companies Act, just like UTI Mutual Fund now falls under SEBI. On the merger of four major regulators, expect wails — this time in the name of farmers — from FMC that sells financial products but simply because the underlying assets are agrarian is not under SEBI where it rightly belongs. The other objection could be on institutional design. As a senior policy analyst said, merging too many institutions could end up becoming risky.

Then, there is the issue of post-retirement sinecures for bureaucrats. Where will retiring secretaries go if four major regulators — SEBI, FMC, IRDA and PFRDA — are merged under one? Of particular interest will be bureaucrats from the Andra Pradesh cadre, for whom the IRDA chair is practically reserved. So, expect cries — in the name of finding the ‘right person’ — from this powerful lobby.

Chaired by justice BN Srikrishna, what I like most about this report is that the seven-member commission has drafted the entire law — the Indian Financial Code — right down to the 16 repeals and more than 50 amendments, a section that needs more analysis and greater understanding of the inter-linkages that will be affected. This is key because Indian financial laws, experts say, have been poorly constructed and carelessly amended. As India moves gears towards a higher growth rate, laws have to move in tune with this changed future. The FSLRC report has created the foundations on which the financial skyscrapers of India’s finance must be built.

You can download the report here:

Volume 1: Analysis and Recommendations

Volume 2: Draft Law

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