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Wednesday, October 13, 2010

Movement on FSDC

MoF press release on FSDC.

For the background on FSDC, see: the budget announcement of Feb 2010, a newspaper column of mine on 16 March, and a collection of responses in the media on 20 March.

Does the FSDC amount to clipping RBI's wings?
The FSDC is only a committee. It is not backed by law. So nothing changes about RBI's role and function.
RBI staff have done speeches saying that financial stability is their job.
The RBI Act does not contain the word `financial stability'. So while some in RBI might aspire to such a function, the present role and function of the RBI does not include financial stability.
The FSDC is not a new law, it's merely a committee, so what changes? We already had the HLCC. What changes with the FSDC?
The FSDC is intended to have a full-time technical secretariat which will work on the problems of financial stability and development. This is something the HLCC lacked. And, the HLCC was chaired by the RBI Governor. He was unable to resolve three classes of situations: (a) Differences between two financial agencies such as the ULIPs question, (b) Differences between two financial agencies when one of them was RBI and (c) Problems of financial stability which require system thinking, which no one Indian agency is good at understanding, given the silo system that is in place. The FSDC should fare better on all three fronts by virtue of being chaired by the finance minister (and backed by a strong secretariat).
So will the FSDC help matters?
It all depends on the staff quality that DEA is able to put into it. The "strong secretariat" is only an aspiration at the present moment.
What is the right role for autonomy for an agency external to MoF?
There are two clear areas where autonomy is required. The first is about specific transactions. As examples, what entities get bank licenses or exchange licenses? Or, when RBI/SEBI investigate Bank of Rajasthan or MCX-SX. It is highly desirable for MoF to be completely hands-off on these kinds of activities of agencies external to MoF. The second is about monetary policy, i.e. the setting of the short-term interest rate. For these two areas, there is a strong and clear case for de-politicisation and autonomy. In other questions, the case for autonomy is not clear-cut.
So is it okay for MoF to meddle in the decisions of an external financial agency on subjects like the policy framework for exchange ownership, or the rules about private bank entry?
The staff quality that DEA is able to put into these functions is supremely important. It is possible to do this right.
Is FSDC opening a Pandora's box by asking too much of DEA staff quality?
I think it is an attempt in the right direction. Largely speaking, it is converting the existing de facto arrangements into de jure with greater formal structure. If FSDC builds up top quality staff, then it will make progress. Else, it will be irrelevant and the present will continue mostly unchanged.
There will of course be ups and downs, but when I look back at the brainpower at DEA from 1993 onwards I feel optimistic about the expected value of FSDC.
The attempt at building a team which works on financial stability and development is an important and a good one. Success on putting together a top quality team cannot be taken for granted. But at the same time, if MoF had not tried this, there would have been a certainty that such a team would not have come together. It is possible to spin this in a gloomy way, but an oversupply of cynicism can crowd out attempts at progress.


  1. "monetary stability": In terms of Section 42 (1) of the Reserve Bank of India Act, 1934 the Reserve Bank having regard to the needs of securing the monetary stability in the country, prescribes the CRR for Scheduled Commercial Banks (SCBs) without any floor or ceiling rate.
    The Merriam Webster dictionary ( "monetary" means "of or relating to money or to the mechanisms by which it is supplied to and circulates in the economy". I think this looks like financial stability. Can there be financial stability without instability in money or to the mechanisms by which it is supplied to and circulates in the economy???

  2. "Monetary stability" is interpreted as price stability. That is indeed the fundamental role of a central bank. Financial stability is a wholly different territory.

  3. Dear Professor Shah;
    On financial stability, it seems that we are moving in opposite direction to the world. In United Kingdom, latest developments indicate that the financial stability mandate is clearly given to the Bank of England. An interim Financial Policy Committee (FPC) has been established on February 17, 2011 as a committee of the Bank of England’s Court of Directors. This is expected to be formalised through legislation as outlined in the Government’s consultation document ‘A new approach to financial regulation: building a stronger system'.[Document available at ]
    The Government's consultative document clearly gives mandate of financial stability to Bank of England.
    Para 1.13 of consultative document says 'The FPC will create the locus for macro-prudential regulation that is missing from the current framework. Responsibility for financial stability will be clearly located in the Bank of England, with macro-prudential policy the preserve of the FPC, and micro-prudential regulation the responsibility of the PRA (Prudential Regulation Authority, [to be a subsidiary of Bank of England]), alongside the Bank’s current responsibilities under the special resolution regime and as a lender of last resort. By locating these distinct but complementary functions within the Bank of England group, the Government will ensure that systemic and firm-specific regulation are coordinated, and that the market knowledge and economic expertise of the central bank is fully brought to bear on financial stability'.
    The Government envisages that the FPC will contribute to the Bank’s financial stability objective by identifying, monitoring, and taking action to remove or reduce, systemic risks with a view to protecting and enhancing the resilience of the UK financial system.
    In India, FSDC appears to be a retrograde step with regard to financial stability.


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