It’s not time yet for a super regulator: Financial Express: 23rd June 2010

The financial crisis has engendered some new thought processes in the UK. The abolition of the Financial Services Authority (FSA) has been hyped into a Cameron-Brown spat, as the FSA was groomed to a position of power by the earlier government, which George Osborne has abolished, or rather reduced to the status of a subsidiary of the Bank of England. Others say that it was a punishment for its failure to tackle the crisis and foresee the Northern Rock Bank crisis. These are stories that may not be germane to us in India, but closing down a regulator brings to the forefront some ideological issues.

Britain tried to follow the single regulator model for markets, which is also under consideration in India, albeit at a stage where the concept of a super regulator is being debated. This is of consequence because our financial system has a plethora of regulators. There is RBI for banking, Sebi for capital markets, Irda for insurance, PFRDA for pensions, Nabard for agricultural finance, FMC for commodity futures trading, Sidbi for SME finance, NHB for housing finance, and multiple APMCs for spot trading in farm products. With different ministries involved, there has been talk of whether there should be convergence to one super regulator. Needless to say, there are ubiquitous pros and cons on both sides.

The British story sort of vindicates the view that a single regulator cannot work well and, therefore, there is a case for having separate specialised regulators for each market. The FSA used to control all financial services, exchanges, firms, small businesses and even high net worth individuals, who had a dotted line reporting. There is also a strong case for separate regulators when markets have to be developed as is the case with, say, pensions, insurance, commodities, etc.

But then there are turf wars across ministries and regulators as players span across different regulators. Banks today are not just commercial banks but have housing, capital markets and insurance divisions. The latest case of Ulips involving Sebi and Irda has been settled for the time being; but the conflict between, say, the FMC and Sebi remains, where players like mutual funds and FIIs are not allowed in the commodity space, as there are separate regulators and Acts guiding each. The Acts are old, with the FCRA (commodities) dating to 1952 and SCRA (securities) to 1956. One has to tread carefully to ensure that risk does not flow from one sector to another. With such a complexity of markets and regulators, it appears that there is need for specialisation or else management will become a problem. But a larger number of regulators resulting in regulatory overlap tends to slow things down.

The other interesting takeaway is the responsibility of the regulator for failure. It may not be true that the FSA has been relegated to a secondary position because of the failure of Northern Rock. If that were so, then the same has to be applied to the Federal Reserve, since it is largely agreed that Alan Greenspan was responsible for the crisis by allowing such a bubble to build up. Clearly, regulators cannot be closed down for failure, as that would make them even more cautious and retrogressive in their overall approach. But the regulator should distance itself from the regulated, or else the former will have to shoulder direct responsibility in case of a systemic failure.

The other issue that is being discussed is the need to break up big banks. Grapevine has it that HSBC and Standard Chartered are already thinking of getting themselves registered in Asia. Again, while this may be an emotional economic outburst against the background of the crisis, it is relevant to us. In India, the talk has always been about consolidation on grounds of gaining critical economic size as well as tackling issues of capital for expansion. The so-called Godzilla syndrome permeated banks’ thinking in the last decade, where they looked at one another for possible consolidation stories. However, given the domination of the public sector banks, it was more a case of the private banks looking at one another. Ultimately though, in most cases, consolidation has been more on account of loss of interest of the promoter or shaky financial positions, necessitating mergers.

We have to think harder now on issues of a super-regulator and whether there would really be any value addition. The current system has worked reasonably well and brought about development, at the cost of ‘time’ perhaps. So regulators should definitely not be closed down for failure.

Finally, there seems to be some merit in not getting carried away with consolidation and a case for better supervision and risk management when it does take place to eschew the build-up of a crisis.