## Friday, July 04, 2014

### Raghuram Rajan's criticism of FSLRC

1. Have you and Ashima writes articles over a heated-arguments-filled-intellectuals-dinner-party !!!!

and if that's not the case... Is FSLRC perfect ? I wonder.
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2. I'm always skeptical of "full rewrites". Incremental changes are usually less risky. People misguidedly channel their frustration at the unsuccessfulness of small changes to thinking that "revolution" is the key.

But I think that rarely works. Take the tech sector. Most attempts at cleaning up a field of hacks by rewriting the specs or codes have been abysmal failures.

Writing a " clean coherent modern law " is elegant & tempting but in practice I think small incremental changes are what's going to work.

Yes we have scandals & mistreatment of consumers & a million other ills that ail the system. But it's hardly that a clean rewrite is going to somehow magically take care of all of this.

In this case, I think your fix is worse than the problem.

3. Its not a re-write. A re-write implies a working system that is being replaced. We don't have a working system in the first place and so, its not a re-write but a first attempt at putting something in place. And, for the same reason, there is hardly any risk as there is hardly anything worthwhile to keep around. The only risk is to the various incumbents who have their cosy place in the current system.

We have Windows 95 and want to move to Windows XP. Once we have XP, we can say that Vista would be a bad idea (as you seem to suggest).

I haven't been able to read your defence of the FSLRC recommendations but I think Rajan had some serious points.

Judicial review of RBI policy decisions? Really? Is that what we want? As if the judiciary is not interfering in policy development and even developing policies on its own already. There is a guest-blog over here that points out serious issues with the judiciary. Rajan is comfortable with an SAT-syle appellate body that will deal with administrative issues but he is leery of allowing judicial reviews of policy decisions. I can understand why. The way things work in this country it is a recipe for gridlock and interventions from complete non-experts.

His other criticism was the schizophrenic take of FSLRC that talks about synergies but points to no empirical information that would validate them while at the same time talks about chopping the regulator into multiple ones. Why didn't the FSLRC take an evolutionary approach?

Maybe you did address the above points in your article. I just cannot find it. I even googled for it. But you haven't even posted the title of the article here.

If you do have the ears of the powers-that-be, please reconsider the revolutionary approach that you espouse. It will only further enable an overreaching judiciary. Let us take it slowly here as there are so many other reforms that are absolutely necessary for job creation. Without job creation we are looking at a real ugly revolution on our streets and we don't want that.

1. The word policy' is not legally precise and should be avoided.

In financial regulation, there are exactly two legal instruments: regulations (i.e. law) and orders (i.e. an award of a punishment for a violation of the law).

Should RBI have the unchecked power to write regulations even when these are ultra vires the primary law or the Constitution of India? I personally think not; I think the threat of appeal will produce better quality regulation-making by RBI. But even if we agreed that RBI should have the power to write law without checks and balances, we'd have to go change the Constitution of India. As that's not on the agenda, any law which creates a mechanism for writing regulations or orders will involve an appeals mechanism. We have only two choices: To do it badly (using the high court) or to do it better (using adequately resourced tribunals).

Should RBI have the unchecked power to write orders? I personally think not. The way RBI works today in writing orders is inconsistent with the rule of law. Example: http://ajayshahblog.blogspot.com/2011/03/rule-of-law-pair-of-stories.html . SEBI used to write such bad orders in the past. It got fixed by SAT. I think the threat of appeal will produce better quality of enforcement by RBI.

All this is about financial regulation, i.e. the work envisaged for RBI in banking and payments. There is no concept of appeal in monetary policy under the IFC so that question does not arise.

About changes to the role and function of RBI, this ground has been covered numerous times in previous expert committee reports. Everyone in India agrees on these things, other than past or present RBI staff. :)

Why not take an evolutionary approach? Important progress has not been achieved in Indian finance by doing evolutionary stuff. RBI did evolutionary stuff for 20 years, and it has presided over stagnation and failure. Revolutionary stuff was done on the equity market or in pension reforms. That's where we made progress. It is not possible to implement the Percy Mistry or Raghuram Rajan reports incrementally. We need to take a big step.

2. +1 to what Anon. wrote.

OTOH, the theme for judicial overreach is already set when you get a jurist to chair a committee on financial reform.

No doubt laws need to be written, but is that enough of a justification for a person with no experience of the sector to chair the commission? Does this happen in other nations? Do ex Judges chair finance commissions in the US?

I think Ajay's view of financial regulation is a bit narrow: There's another alternative akin to the US "Rulemaking" model. i.e The legislature draws up a broad mandate and then leaves it up to a specialized body e.g. RBI, EPA etc. to draw up the detailed rulemaking.

The judiciary will only step in if a particular rule exceeds the broad mandate or clashes with some fundamental constitutional principle. Not the Indian style of interventionist judicial rulings where every minute rulemaking or decision is up for re-interpretation by the judiciary.

3. Financial reform has to be implemented by legal change. It is therefore necessary to involve jurists and lawyers in programs that involve reform through legal change.
There is no "different" model of rule-making/regulation in the US. All rule-making is subject to judicial review. It is a different matter that US courts are less "interventionist" than Indian courts. We cannot write laws to prevent judicial review in the fear that the judiciary will be interventionist. We may require efficiency from regulators, but we cannot sacrifice the Constitutional principle of checks and balances for the sake of efficiency.
And like Ajay's article says - if we think judicial review of financial regulation is untenable because of the complexity involved, let's also kill judicial examination of forensic evidence in criminal investigations and patent disputes.

4. No doubt laws need to be written, but is that enough of a justification for a person with no experience of the sector to chair the commission? Does this happen in other nations? Do ex Judges chair finance commissions in the US?

India has the tradition of law commissions' which goes back to 1834. These are non-partisan expert groups. In the US, the drafting of law is much more connected to petty politics.

India is littered with malfunctioning government agencies. What is required in solving them is a general technology of public administration and rule of law. The approach of FSLRC is actually sector neutral and can be applied across the landscape.

I think Ajay's view of financial regulation is a bit narrow: There's another alternative akin to the US "Rulemaking" model. i.e The legislature draws up a broad mandate and then leaves it up to a specialized body e.g. RBI, EPA etc. to draw up the detailed rulemaking.

Please study the FSLRC report. This is exactly how all financial regulation works.

There is a Principal-Agent problem. When you hire the RBI or the EPA to do work for you, do you give them an expansive mandate and hope for the best? No, you give the Agent a specific objective, and hold him accountable. We have low performance agencies like RBI in our landscape because they have been given vague objectives, sweeping powers and lack accountability.

The judiciary will only step in if a particular rule exceeds the broad mandate or clashes with some fundamental constitutional principle. Not the Indian style of interventionist judicial rulings where every minute rulemaking or decision is up for re-interpretation by the judiciary.

The law is the contract between Principal and Agent. The judiciary is required to step in when the Agent violates this contract.

5. Indeed India has a long tradition of such jurist headed commissions. But that does not make it axiomatically a good tradition. What worked in 1834 may not work now. The expertise required of a commission studying the complexity of today's finance sector is no comparison to what an intelligent judge may have been able to comprehend 150 years ago.

India also has other anachronistic traditions (e.g. the Indian Administrative Service) but we'd be better off critically examining these instead of always following legacy traditions.

@Ajay: Is the mandate given to the US Fed or EPA more specific than what we give the RBI in the status quo? Sincere question. I'm not sure but I'd love to know.

Also, I think you are attacking a strawman by asking whether the "RBI have the unchecked power to write regulations even when these are ultra vires the primary law or the Constitution of India?" I doubt anyone (especially Rajan) would be crass enough to suggest that.

The crucial distinction remains between (a) broad oversight where judiciary steps in reluctantly only when constitutionality or some fundamental principle of justice is violated versus (b) an active oversight where the contract between your Principal & Agent is spelled out in great detail and the judiciary vigilantly polices the details.

To characterize the opponent's position as "sacrificing the Constitutional principle of checks and balances for the sake of efficiency" is wrong I feel.

7. Dear Ajay,

I was the anon who sparked this debate. Thanks for responding to me and I am happy to see that the discussion has gone further.

I have nothing to do with the RBI. I am a layman from the private sector though I do or did have strong links to the bureaucracy. So there might be some bias on my side.

It would have been great if more laymen joined policy debates with a deeper understanding of the issues rather than the jingoism that we see around us in India (not on this blog).

It would be great if you could address issues raised regarding the FSLRC recommendations in a separate blog post.

Having said that I do see your point after the way the RBI acted with respect to Uber. There must be an independent option for redressal for such policies.

8. The summary of 20 years of work in Indian finance is this: Mistakes like RBI & Uber will be less common under the Indian Financial Code.

5. I've been reading the FSLRC report in greater detail & I cannot be but concerned about the regulatory overreach this seems destined to create.

Case in point: Section 142 of the Draft Law. I paraphrase: "No person should carry on the business of providing a financial service in India unless that person has obtained authorization from the regulator."

To me this seems a section very ripe for abuse. Are we going back to License Raj? "Providing a financial service" is a rubric so broad that I cringe to think of what all could be brought under its purview.

And this was a conscious "feature" not a bug. Varma's note of dissent makes that amply clear.

I'm not sure whether this is an outlier or captures the flavor of the FSLRC, but in the context of this I am more sympathetic to Rajan's concerns.

6. As as aside isn't it ridiculous that in today's world the DICGC will only protect the first Rupees 1 lakh of a customers deposits in a failed bank? What sort of grossly inadequate cover is this? It is like the IRDA allowing an insurer to sell a policy that only covers the flu. PS. Will the IRDA even allow a health policy to be sold that offers a coverage cap of just 1 lakh rupees?

I'm not sure what the sound economic methodology is to figure out what "adequate" coverage is but 1 lakh doesn't sound like it. As a comparative datapoint the FDIC covers the first $250,000 of a customer's bank deposits. Of course we cannot match that but what's a reasonable number? I wish the FSLRC went into more substantive specifics like this one rather than procedural generics. There's only so much you can do by juggling around powers and swapping one regulator for another. But perhaps I cannot blame the FSLRC because such things might have beyond its mandate? 7. Why does your darling SEBI require a paper request to close a demat account? I can trade, shift funds online, but to close a demat account I have to make a paper request. Why? Is it because there are many defunct demat accounts on which they can continue to charge annual fees? I still don't even understand why I have to open a demat account when I am not dematting anything and only trading online. Why is a demat account MANDATORY when opening an online brokerage account in which I will never demat anything from paper form? No other country requires this, afaik or atleast it is transparent and does not incur annual fees. SEBI is a joke just based on this. And, the entire country has no problem obeying nonsense rules like this. 8. A random observation: Does the FSLRC report have any graphs / equations? Just curious. I didn't spot many in my cursory reading. Is that the price you pay for having a jurist head the commission? Please note: Comments are moderated. Only civilised conversation is permitted on this blog. Criticism is perfectly okay; uncivilised language is not. We delete any comment which is spam, has personal attacks against anyone, or uses foul language. We delete any comment which does not contribute to the intellectual discussion about the blog article in question. LaTeX mathematics works. This means that if you want to say$10 you have to say \\$10.