Mr. Arun Jaitley, Honourable Union Minister of Finance, members of the Institute of Company Secretaries, ladies and gentlemen.
My thanks are due to the organisers of this seminar for giving me an opportunity to address this gathering of professionals and practitioners, who have come here today to meet and share knowledge regarding the Indian Financial Code recommended by the Financial Sector Legislative Reforms Commission (FSLRC) in its report submitted last March [report, law]. I am happy to be here today to speak to you about an important component of economic development that has engaged even the attention of the President of India, as reported on the front page of the Indian Express yesterday.
As all of you are aware by now that there are nine key components of the legal framework recommended by the Commission. These are:
- Consumer protection and competition,
- Micro Prudential Regulation,
- Systemic Risk,
- Capital Controls,
- Monetary Policy,
- Public Debt Management,
- Foundations of Contracts and Property.
The principle of consumer protection is an important determinant of the way governments and regulators think about their job. It is part of the invisible legal architecture that frames our choices, and shapes our lives. And yet, very few regulators have a precise understanding of what constitutes consumer protection. Some believe consumer protection is best served by holding financial literacy camps. Others believe consumer protection is best served by an ombudsman or by setting up an investor protection fund. While one cannot gainsay that these are important activities, consumer protection is much larger and requires an attitudinal change towards regulation.
Since there are no precise definitions of consumer protection in existing law, regulators claim the flexibility to do many things, some necessary and many not, under the garb of consumer protection and claim that the regulated should have a `healthy respect' towards them. Also, because consumer protection is not precisely defined, many regulations framed by regulators do not do enough to protect consumers. Moreover, in a developing country like ours, regulators often feel the need to develop the market, and in their enthusiasm inadvertently establish low thresholds of consumer protection. The need of the hour is for clearly identifying what constitutes consumer protection in the field of finance, and what tools regulators should develop to protect consumers.
As you know, I was fortunate enough to be associated with the Financial Sector Legislative Reforms Commission, as its Chairman, and its report is already in the public domain. The FSLRC and its members spent two years of intense research, consultations, deliberations and drafting, supported by a technical team of 30. In all, 146 people were involved in the Commission's work, including lawyers, economists and other domain experts from India and abroad, bringing with them decades of accumulated experience in finance, regulation and public administration. The aim of the Commission was to examine the foundations of the Indian financial system, raise fundamental questions unasked hitherto, attempt answers to them and recalibrate the financial system to align with the aspirations of a liberal democracy, namely that it should be open, transparent, and governed by the rule of law. The Commission's work involved asking difficult questions about the purpose of regulation, the role of the state, and the checks and balances required to make the system fair and accessible while being efficient and effective.
Though, the report of the Commission was released last year, along with the draft Indian Financial Code, the work started by it is far from over. Forums such as this are important opportunities to continue those debates in the public domain. Those are debates about democracy, fairness and justice just as much as they are about incentives, systems and signals. That is why it is so important for all of us to dispassionately participate in the debate so as to arrive at a consensus unhindered by the drag of status quo-ism.
There were a number of critical topics that were discussed during the writing of the FSLRC report, and consumer protection was an important one. All financial laws in the country are intended for the consumers, and regulators are the arms of the State to ensure that benefits reach the ultimate beneficiaries. The FSLRC report recommends a decisive move away from the old concept of 'caveat emptor,' or 'buyer beware,' towards a 'seller beware' regime. In such a regime, financial service providers must assume greater responsibility and care when recommending or selling products and services to consumers. This move is motivated by the realities of modern financial services, on the one hand, and the realities of an emerging market like India on the other. The deleterious consequences of the buyer beware approach is seen by us in real life today. When consumers are duped on a mass-scale by private entities within a buyer-beware attitude to regulation, there are few efficient mechanisms for recompense to the consumers. Consequently, there is an overreaction from government agencies who go into an overdrive to overkill by banning entire sectors of economic activity. We thus get caught in an adverse cycle of under-protection and over-reaction. We must surely ensure that the baby is not thrown away with the bath water!
As a general experience, financial service providers are in a position of massive bargaining power relative to all but their largest clients. Consumers are generally less informed about finance than financial firms, and typically not able to band together to defend their interests. India is an emerging economy: it cannot be taken for granted that all consumers are well-informed, or free to reject a contract they feel is unfair. The FLSRC therefore recommends a system-wide commitment to consumer protection, in which all regulators build relevant protections into their respective regulations. One critical priority is to mandate that financial service providers make clear, adequate and relevant disclosures to the consumer, and ensure that - based on the consumer's expressed needs - the product or service being offered is suitable for that consumer. Allow me to remind you all of the critical role you have to play, as you work to bolster development, in making that development more rule-bound and fair, and thus less fragile than if it were to come at the expense of the Indian consumer.
Let me turn for a moment to the broader debates I alluded to earlier about the fundamentals of a democratic system. Financial regulation, inasmuch as it is regulation - that is the application of the coercive power of the State to private parties - is not easy. As we pointed out in our report, and as any regulator would agree, regulation is technical work, requiring care, attention and expertise. It is precisely because of that complexity that we have created regulators in the first place: specialised bodies, who will accumulate knowledge and human capital, and will build institutional knowledge and physical infrastructure and information networks that allow them to rise to the challenges at hand. In order to be effective, regulators must have the legal mandate to formulate regulations, to allocate resources as they see fit, and to act decisively. All this contributes to an environment in which private parties can operate freely, and with clarity and confidence. I mentioned how we worked to strike a balance, and design a system that is fair and accessible while being efficient and effective. Striking this balance is complicated because many of the things we do to make regulators more effective, also diminish their accountability to Parliament, and to the people. After all, we cannot forget that regulators - like the State that they represent - are for the people and not vice versa.
The problem is that we have created regulators that function as 'mini-States.' In our larger Constitutional framework, we have separated the critical functions of the government - legislative, executive and judiciary - and placed them with separate bodies. This system of checks and balances is meant to prevent the government from acting outside the law. When we create a regulatory body, we often find it necessary to give that body the ability to write regulations, conduct investigations into the violation of those regulations, and adjudicate on the violation afterwards, which implies a lack of separation of powers. One partial solution to this is to at least separate out those functions within the regulator, and assign separate staff to carry out each function.
Let us take the case of adjudication: When the investigation staff of a regulator takes action against a regulated entity, they must provide it with an opportunity for a hearing before the regulator. When it appears before the regulator to represent its case, it should not before the investigation staff, but someone who will act as a neutral third party. This requires building a separate adjudicatory capability within the regulator, with dedicated staff - headed by an Administrative law member and staffed by lawyers. The person hearing the case should show no bias towards the investigation staff. He needs to be able to give a fair hearing, and, if necessary, decide against the investigatory staff. It is work to build this internal separation of powers, but it is absolutely critical to the rule of law. The game must not be rigged.
It has been argued that these internal safeguards are the only ones that are required to ensure that regulators remain within the bounds of the law, and that any interference beyond this will compromise their work. It is argued that the work of regulators is nuanced, esoteric and complicated, and that regulators need to preserve flexibility and freedom of action to respond decisively to events in the world. Under this view, there is a fear that judges will second-guess the actions of regulators, which is a short step from encroaching on the domain of policymaking. We disagree. We believe that in a democracy wedded to the rule of law, no one, not even a regulator, is above the law. Our response to the difficulty of building checks and balances in a specialised area of regulation, is to build a specialised mechanism - not to give up on checks and balances!The proposed Financial Services Appellate Tribunal, would fulfill this role. It will be staffed by personnel with relevant domain knowledge, training and experience, and it is designed to adjudicate openly, efficiently and in an informed manner: the disputes between regulators and regulated entities. Yes, one can argue that a new tribunal will not have the institutional knowledge required to appreciate the subtlety of a regulator's action, and rule fairly. But the first thing to keep in mind is that the regulator must be able to explain its actions. If it can explain its actions to judges of the High Court or Supreme Court, neither of whom can claim expert knowledge, it can surely explain its actions to a Tribunal that can lay claims to such expertise. The second thing to keep in mind is that institutions evolve, and they evolve together through their interaction. Sometimes, that interaction may not be smooth, but may involve some tension. But that is the point of democracy, which is a system of checks and balances. A healthy tension between institutions is what makes a liberal democracy grow. In the years since the Securities Appellate Tribunal was set up, to hear appeals from SEBI orders, the quality of SEBI orders has increased. And so has the quality of SAT decisions. Regulators should take comfort in this fact.
Thankfully, the independent academic Dr. Rajan also disagrees with the RBI Governor Dr. Rajan on this aspect. In his 2009 report, A Hundred Small Steps, Dr. Rajan wrote, "Regulatory actions should be subject to appeal to the financial sector appellate tribunal." This is the thinking that guided the FSLRC's deliberations, and it is the position we still take today.
Allow me to share a few thoughts from the experience of the FSLRC: Those of you who have looked at the Commission's report will know that it has recommended re-organising India's financial regulatory architecture. Again, it is a topic that may easily get passed over by many people as esoteric, but all those who are connected with the financial field you would acknowledge that it will profoundly affect the Indian financial ecosystem. What is the logic behind this reconfiguration? The proposed regulatory architecture allows regulators to look beneath the surface of a product or service and unmask its essentials, be it termed a loan, an insurance scheme, or an investment, and regulate it according to the risk it poses to the system, and the probable risk that a firm may not fulfill its promise to a consumer. I fear that criticism of the proposed framework glosses over this critical argument, which is actually about more than just operational synergy. It is the result of soul-searching rethinking of the way we draw the lines around various kinds of financial activity and compartmentalise them, leading to avoidable turf wars. It is driven by a more agnostic view of risk management, both at the systemic level and at the level of individual firms. It is intended to underline the consumer as the focal point of the debate.
Finally, is this a leap into unknown territory? Hardly. This is the approach that many countries have implemented already. And yet, it is a bold move. But it is one that the Indian financial sector and the Indian consumers deserve. Our financial architecture has become unwieldy and unresponsive. Provisions that were intended be temporary (the RBI Act of 1934 is an example) have become permanent. Sometimes this is a result of inertia, rather than careful planning. Arrangements that were the best we could do at the time, are now considered to be the only way to do things. One fears that as a result, parts of our regulatory machinery have become brittle, fragile, or worse, completely irrelevant and utterly useless, if not downright harmful to our interests. It is this concern which motivated the proposed reforms. This is not change simply for the sake of change. And indeed what we proposed is far from cosmetic. This is fundamental re-engineering of a sector that desperately needs it. To push ahead with our current arrangements and simply hope for the best, would indeed be reckless, despite our known reliance on jugaad.. We must reform in anticipation of future crises, not only in response to past ones. Our preparedness for the future requires that our institutions and our systems be world class, when we expect our GDP to be in the region of about 20/30 trillion USD in about 15/20 years, and we entertain the ambition to be one of the leading leading players in the world's financial arena. Only legislation can drive institutional change to yield the high performance institutions that we need. Change is necessarily disruptive; hence people abhor it. Reform unsettles the powerful; hence it ruffles feathers. But it is necessary and it must be done now.