FSLRC's institutional architecture
The draft Indian Financial Code (IFC) envisages seven financial agencies outside the Ministry of Finance:
- Financial Sector Appellate Tribunal (FSAT): An improved version of the existing Securities Appellate Tribunal which will hear appeals all across the financial system.
- Public Debt Management Agency (PDMA): The investment banker for the government.
- Financial Redress Agency (FRA): The one-stop shop where any individual goes to raise a complaint about a financial service provider, where the difficulty was first raised with the financial service provider but not satisfactorily resolved according to the consumer.
- Resolution Corporation (RC): A specialised organisation that will handle distress in certain kinds of financial firms.
- Financial Stability and Development Council (FSDC): Systemic risk, coordination, development. This contains a database named Financial Database Management Centre (FDMC), which is the one-stop shop where all financial service providers electronically submit all the data that they have to give to financial agencies.
- Unified Financial Authority (UFA): Consumer protection and micro-prudential regulation for all finance other than banking and payments.
- Reserve Bank of India (RBI): Monetary policy, and consumer protection and micro-prudential regulation for banking and payments.
It is one thing to design a clean financial regulatory architecture. The next challenge lies in implementing it. Let's think through what's required for all the 7+1 agencies.
- FSAT builds on the best tribunal in India today, SAT, and will become a high quality court. It has to plan for the much higher case load that will come to FSAT under the IFC when compared with the present arrangements with SAT.
- PDMA is a capability which is absent today. Subsets of the work that PDMA has to do are to be found within RBI and MOF but the full task is not being performed in India today.
- FRA: at present, there are multiple ombudsman systems running in RBI, SEBI, IRDA, etc. FRA brings these together under one roof, with a high quality IT system.
- RC: Is a new capability which does not exist in India today.
- FSDC: Is an enlargement of the existing FSDC, which gets shifted out of the Ministry of Finance. FDMC has to be built.
- UFA: In terms of the areas covered, it is a merger of SEBI, PFRDA, IRDA, FMC and some things which are presently in RBI. In terms of the work being done, it is different from what these agencies do today.
- RBI: In terms of the areas covered, banking and payments and monetary policy are in RBI, but these things are done in different ways under the IFC.
- MoF: The IFC has important implications for MoF which has to think and work in new ways. Many people have not noticed the big changes that flow from the IFC for MoF.
The key bottleneck in India: State capacity
Once Parliament enacts a law, this has to be enforced, either by an agency (e.g. RC) or by the main line structures of government qua government (e.g. MoF). We in India have a long history of under-performance in the enforcement of laws.
This is partly grounded in badly drafted laws, which lack accountability mechanisms, lack clarity of purpose (which reduces accountability) and embed extreme executive power and discretion (which reduces accountability). The underperformance of RBI or SEBI is partly the consequence of drafting problems of the RBI Act and the SEBI Act.
But the underperformance is also grounded in bad public administration. A lot of new work is required in public administration, so as to obtain good quality execution. Alongside bad laws, bad execution is an equally important source of underperformance. This takes us to questions like organisation diagrams, HR policy, process manuals, reporting, internal IT systems, etc.
In developed countries, there is rapid execution in the implementation of new laws. E.g. the UK was extremely impressive in their translation of their new law for resolution of financial firms into State capacity for enforcement. In India, the experience has been that it takes a long time to implement, and particularly to implement well.
It will take some time for the IFC to get enacted. Recognising the bottlenecks of State capacity, we should worry about the delays, and about the quality of the execution, in living by the IFC once it is enacted.
Building institutional machinery ahead of time
Reflecting these concerns, there is a long tradition in India, of building institutional capacity before a law is enacted. Here are a few examples:
- SEBI was created by executive order in 1988, and the law came in 1992.
- PFRDA and NPS were constructed 2003-2005, while the PFRDA Act was enacted in 2013.
- NSE started building Nifty and the real-time risk management system for derivatives trading at NSCC in 1995, while cash settled derivatives only became enforceable in 1999.
- Work on building the depository began inside NSE in 1995, before the legal foundations for dematerialised settlement fell into place in 1996.
- Work on the IT systems for the Goods and Services Tax (GST) began at NSDL in 2011, and the GST has not yet been enacted.
These are just a few examples that I have been around; there are many other episodes of this nature. The general principle is: Once the direction of future legislation is clear, project planning for enforcement of the law commences. Hence, once the budget speech of 2014 has established the legislative direction on the IFC, we should now build the institutional machinery through which the IFC would be enforced.
The MOF announcement today
Today, the Ministry of Finance has announced `Task forces' to build four components of the institutional machinery of the IFC. They are:
- Financial Sector Appellate Tribunal (FSAT). Chairman: N. K. Sodhi.
- Public Debt Management Authority (PDMA). Chairman: Dhirendra Swarup.
- Resolution Corporation (RC). Chairman: M. Damodaran.
- Financial Data Management Centre (FDMC). Chairman: Subir Gokarn.
The press releases are : overall, FSAT, PDMA, RC, FDMC.
Twiddle your thumbs?
SEBI had to twiddle its thumbs from 1988 to 1992 as they had no powers in the absence of the law. NSE built the institutional capability to trade equity derivatives by 1998 and had to twiddle its thumbs till the politics worked out. All situations where institutional infrastructure comes up ahead of time have that tension within, of a race between the legislative process and the State capacity building project. The work of the four task forces that have begun has an array of possibilities, ranging from immediate impact to twiddle-your-thumbs:
- FSAT: If SAT voluntarily chose to use the new institutional capabilities built for the FSAT, then those could be valuable right away.
- PDMA: The new muscles of the PDMA could be of limited use to the Ministry of Finance in some ways that are compatible with the existing law.
- RC: The Resolution Corporation must twiddle its thumbs until the IFC is enacted.
- FDMC: Some or all of existing financial agencies could choose to voluntarily utilise the services of the FDMC, which will be a better IT-driven mechanism for submission of data from financial service providers to financial agencies.
How we got here, and where we go next
The first phase of Indian financial reform ran from the reform of the equity market (1992-2001) and till the setting up of the NPS (2003-2005). Important new institutional infrastructure was created in this period: SEBI, NSE, NSDL, CCIL, IRDA, PFRDA, the NPS. The key features of this first phase were: (a) Responding to immediate difficulties and (b) Thinking one sub-sector at a time. Some parts of Indian finance made enormous progress in this period, such as the equity market and the pension system.
A long period of stagnation followed. This thought process shifted up from one sector at a time to thinking on a financial system scale, looking at the requirements of the economy even without the immediate impetus of a scandal. This started with the Percy Mistry report of 2007, and led up to the IFC in 2013. The IFC is now the centre of Indian financial reform, and is coming about on three tracks: the legislation, the Handbook, and these four task forces.
In many ways, these four projects are more complex than the new institutions of 1992-2005. The institution-building experiences of that period have many lessons, which have been incorporated into the construction and work procedure of the four task forces. E.g. the non-statutory SEBI drafted the SEBI Act, but now we understand that the Agent should not have a say in the contract between Principal and Agent. Similarly, the clarity of the four TORs of the task forces is not to be found in comparable documents from the 1992-2005 period. Institution building that period relied a lot on Level 3 thinking ("the great man theory"), whereas now there is an accent on formal processes that yield predictable outcomes.
All this connects with the core question of bandwidth and State capacity. In the past, one crack team at a time would setup one new institution. There are concerns about whether there is State capacity to implement the IFC, and there is reason to believe that State capacity in financial economic policy has improved substantially when compared with what was available 1992-2005. At the same time, the four task forces are a daunting challenge: doing four new institutions at the same time has never been done before.