The unravelling financial scams in India and inability of financial regulators to address these should prompt a rethink, and a possible redesign, of the regulatory space.

By Amol Agrawal

The National Stock Exchange (NSE) co-location saga is the latest in a series of scams that have rocked the Indian financial sector recently. It reminds one of the famous line by Jean-Baptiste Alphonse Karr: The more things change, the more they stay the same. NSE was started in 1994 to provide an alternative to scam-ridden Bombay Stock Exchange. Nearly 30 years later, NSE, the pride of 1991 reforms, is reeling from a similar set of scams. What is even more worrisome is how India’s financial system is engulfed with problems of misgovernance. We have seen several misgovernance cases in Indian banks and are now seeing the same in capital markets too.

In all these cases, regulators of banking and capital markets—respectively, RBI and Sebi—have also managed to raise eyebrows. What were they doing when these scams were occuring? Both the regulators have extensive powers, and yet have been found wanting. What should be done?

TCA Srinivasa Raghavan, writing in Business Standard, proposes a solution to this problem. His major point is that the flaw lies not in the regulators but the regulatory design. Indian regulators derive their powers from three founts: the Constitution (for instance, the Election Commission), Parliament (TRAI) and the government (RBI and Sebi). The constitution-created regulators are independent (usually), whereas those in the second and third categories can be easily undermined by the ministers and the bureaucrats. The solution is the government granting constitutional status to the financial regulators.Do we have examples where regulators are given constitutional status? While one is not aware of constitutional status being accorded to capital market regulators elsewhere, there are several cases of central banks being given constitutional status.

A study by Bank for International Settlements (Issues in the Governance of Central Banks, 2009) lists 22 countries that have a constitution. Most of the central banks also come from civil law traditions. A glance through the list suggests that the constitutional status differs widely across the 22 countries. The study lists 17 different ways in which constitutional status has been accorded to central banks. Broadly, 13 national constitutions mention that there shall be a central bank in the country, among which eight are granted independence. The 9 constitutions which do not mention ‘there shall be a central bank’, there are provisions regarding powers to appoint/dismiss central bank heads, structure of central bank etc. Of the 22 constitutions, three mention prohibition of credit to government, three have regulatory powers, and so on. As mentioned, there is a lot of diversity in how countries have granted constitutional status to their central banks.

Interestingly, India is on the list of the 22 nations with constitutions. In our Constitution, RBI finds a place only once as Entry 38 of List 1 of Schedule VII, which allocates powers between the Union and the states. This implies RBI’s policies are subject to the Union’s authority, which is how it has been for most of the central bank’s history. Former RBI Governor YV Reddy famously said that RBI is independent within limits set by the government.

Will more detailed and comprehensive constitutional provisions help make RBI (and Sebi) more proactive? The experience in this regard is mixed. There are four Latin American economies in the list of 22—Argentina, Brazil, Mexico and Chile. Barring the central bank of Chile, the other three central banks are often in the news for governments undermining their independence despite constitutional status. One could add central banks of South Africa and Bulgaria to the list as well. The central banks of countries Switzerland, Sweden, and Singapore have a much better track-record, but these are developed economies.

What do we make of the above discussion? The unravelling financial scams in India and inability of financial regulators to address these should prompt a rethink, and a possible redesign, of the regulatory space. In this regard, Raghavan’s proposal for granting constitutional status to RBI (and other financial regulators) is worth examining. Former RBI Governors, YV Reddy and Raghuram Rajan, have also spoken about outlining RBI’s responsibilities in the Constitution.

There is also an interesting connection between India’s Constitution and its central bank. BR Ambedkar, the architect of the Indian Constitution, had studied Indian currency and debated establishing a central bank in his second doctoral dissertation. However, at the time of framing the Constitution, the focus was on other things, and RBI was just mentioned in the Union List. From his heavenly abode, Ambedkar must have noted how some constitutions discuss the role of their central banks in detail. He would have also noted that, despite constitutional status to some of the regulators, their performance has not been as satisfactory.

The government could kickstart the discussion by establishing a committee to study the possibility of according constitutional status to financial regulators.

The writer is a blogger at MostlyEconomics.


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