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Friday, February 17, 2017

Financial Sector Reforms: A status report, 2017

by Ashish Aggarwal.

In this article, I piece together information in the 2017 budget to write a status report on financial sector reforms.

  1. Consumer protection: Three important initiatives are in progress: -

    Financial Redress Agency (FRA): The FRA is expected to provide a unified, speedy and convenient complaint settlement mechanism to retail financial consumers. In the Budget speech of 2015, the Finance Minister had proposed to create a Task Force to establish a sector-neutral FRA. In June 2016, the Task Force recommended enacting a financial sector consumer protection law and proposed an implementation blueprint. It also addressed concerns expressed by RBI and SEBI. RBI has supported the idea of a single grievance redress agency. One example is their submission in the context of regulating deposit taking activities across regulators and State Governments (Twenty-first Standing Committee on Finance, 2015-16, Para 59). The government had recently invited public comments on the Task Force's report. The next steps in this journey consist of draft Bill on the proposed law, and the establishment of the FRA.

    Curbing illicit deposit taking schemes: There is considerable understanding of the problem of ponzi schemes. The twenty-first report of the Standing Committee on Finance (referred above) had recommended various measures to plug the regulatory gaps and overlaps related to deposit taking activities. This year, the Finance Minister has promised to introduce the Banning of Unregulated Deposit Schemes and Protection of Depositors' Interests Bill soon. This is the second version of the draft law and was released in November 2016 for comments. The Government had promised this law in last year's budget as well as in the ATR on the above report. The proposed law aims to empower the State Governments to regulate deposit schemes which today slip through the regulatory cracks. It allows the designated courts to impose significant penalties (Jail up to 10 years and fine of up to twice the amount of total funds collected). It proposes significant powers to the State Governments and the police.

    The Government should use concepts from the draft Indian Financial Code to strengthen the regulating of deposit taking activities by the State Governments. For example, provisions related to accountability (Chapter 14), regulation making (Chapter 17), show cause notices and orders (chapter 25) could be adapted to strengthen the proposed Bill. The clause on warrant-less searches should consider the provisions related to investigation in the draft IFC (chapter 22). These would help improve the balance of regulatory powers with accountability. This year, the Finance Minister has also promised to plug the regulatory gaps in the Multi State Cooperative Societies Act, 2002, as part of the follow up to the recommendations of the above Standing Committee. As part of the clean up, the Government is also expected to soon introduce a Bill to amend the Chit Funds Act, 1982, though that has not been mentioned in the budget documents. Given the extensive nature of changes, it would be doubly useful to harness the work embedded in the draft IFC.

    Securities Appellate Tribunal (SAT): SAT's jurisdiction today covers SEBI, IRDAI and PFRDA. Orders by RBI are still not appealable at a tribunal. Other than that, the scope of SAT now approaches that of the Financial Sector Appellate Tribunal (FSAT), proposed in 2014. In light of the expanded jurisdiction, the Finance Bill, 2017 (S.145) proposes to provide for more members and benches of the SAT, including benches outside Mumbai. This would be achieved by amending the Securities and Exchange Board of India Act, 1992.

    The Government should consider modernisation of SAT's processes and administrative functions. Tribunal members should be able to focus on their case load instead of the day to day aspects of administrative functions like finance, human resource and information technology (Datta, 2016, Towards a Tribunal Services Agency). This would help reduce the time taken to dispose off cases.

  2. Systemic Risk Regulation: Financial Data Management Centre (FDMC) is expected to provide for a nation-wide integrated repository of information relating to the financial sector. It would be used to study systemic risk, system-wide trends and facilitate a discussion about policy alternatives. Para 90(iii) of Budget document on implementation of last year's announcements (Implementation Document) notes that a draft Bill to set up the FDMC is proposed to be placed for public consultation. Last year, a draft Cabinet Note on setting up of a non-statutory FDMC was circulated. Based on the feedback received, the Finance Minister had approved creation of a statutory FDMC. Thereafter, a Committee to suggest a draft law was set up. In October 2016, this Committee submitted its report which included a draft Bill titled Financial Data Management Centre Bill 2016.

    The Government should focus on ensuring that FDMC has the statutory ability to: (i) create a truly integrated repository; (ii) develop capacity to provide research and analysis support to the Government and (iii) ensure that the Data Centre has the ability to evolve with the changing requirements over a period of time. It would be a sub-optimal if the FDMC would need to rely on the executive powers of the Government/ FSDC or the willingness of the regulators to achieve its objectives.

  3. Digital Payments: The Committee to review framework related to digital payments has, as part of its report, suggested that regulation of payments should be separated from the central banking function of the RBI. This year, the Finance Minister has proposed creation of a Payments Regulatory Board (PRB) within the overall framework of RBI to regulate payments. The proposed PRB has equal representation from RBI and nominees of the Central Government, with the RBI Governor being the chair (S.148, The Finance Bill, 2017). In the proposed PRB design, no decision can be taken unless RBI agrees. However, this is an improvement over the present regime where a sub-committee of the Board of RBI is regulating payments.

    The Finance Minister has said in his budget speech that the Government will undertake a comprehensive review of the Payment and Settlement Systems Act, 2007 and bring about appropriate changes. This would be a major reform in this field.

  4. Monetary Policy: In March 2015, as part of its monetary policy framework agreement, India had established inflation targeting as a goal for RBI. In June 2016, the Parliament amended the RBI Act to require the Government to set a CPI based inflation target once in every five years (S.45ZA). A six member Monetary Policy Committee (MPC) was designed to determine the Policy Rate required to achieve this target (S.45ZB). RBI and Central Government have three votes each on this Committee. In case of a tie, the RBI Governor has a second vote. In addition to creating institutional capacity, this reform brings transparency to the decision making process. Section 45ZI(11) requires each member of the Committee to record the reasons for voting in favour or against the resolution. Section 45ZL requires the RBI to publish the minutes of the meeting with details of vote of each member and the reasons recorded by them. Para 90(ii) of this year's Implementation Document notes that action on this reform has been completed.

    The Government should re-visit the design of the MPC in the future. In the current design, the RBI does not need to convince even one non-RBI Committee member on its policy stance for the decision to go through.

    The Government should use the MPC meeting process to develop a cookie cutter approach to improve working of regulatory forums. The effect of these amendments is immediately visible. Contrast the detailed minutes of the MPC with the brief disclosures of the meeting of the Central Board of RBI, held around the same time (Minutes of MPC meeting, December 6, 2016 vs. Release on the 562nd meeting of the Central Board, December 15, 2016). The meeting of the Central Board is summarised in 150 characters, excluding details of attendance etc. The tweet style disclosure of the Central Board meeting is not a one-off. The immediately previous meeting details are also 150 characters long and are, co-incidently, exactly the same in content. The gaps in the quality of disclosures are glaring when we make international comparisons (Patnaik and Roy, 2017, The RBI board: Comparison against international benchmarks).

  5. Capital Controls: This year's budget speech proposes the abolition of the Foreign Investment Promotion Board (FIPB) in 2017-18. It notes that the FIPB has successfully implemented e-filing and online processing of the FDI applications. It proposes that the road map for abolition of FIPB would be announced over the next few months. The Government has also indicated its desire to further liberalise the FDI policy. The abolition of FIPB would be a significant step if abolition is achieved in substance.

    Government needs to ensure that important reform steps do not slip through or get stalled. Control on all capital flows is exercised by the RBI, in consultation with the Government. The Finance Act of 2015 (S.139) had amended Section-6 of the Foreign Exchange Management Act, 1999 (FEMA) to provide that control on non-debt capital flows would be exercised by the Government, in consultation with the RBI. This amendment has not yet been notified. This requires the Government to first issue a notification distinguishing debt and non-debt instruments. One would have assumed that once the Parliament has amended a law, the government would be able to notify the same in a reasonable time.

  6. Government debt management and its bond market: Two important initiatives are in progress: -

    Public Debt Management Agency (PDMA): In October 2016, the Government took first step by setting up an advisory Public Debt Management Cell (PDMC). The Office Memorandum notes the functions of PDMC and mentions a two-year (October 2018) journey towards a statutory PDMA. The Finance Bill, 2015 (Chapter VII) had proposed setting up a PDMA but the move was rolled back in April that year. This reform appears to be back on track. However, the first real progress would be to introduce a law that would establish the agency (Pandey and Patnaik, 2016, Legislative strategy for PDMA).

    Unified market for government securities: This reform appears to have lost traction after the 2015 roll back of the move to shift regulation of bond market from RBI to SEBI. The Finance Bill, 2015 (S.157) had proposed to create a unified market for government securities. There is some action in this Budget aimed at improving retail participation in government securities. It also captures some initiatives aimed at deepening of the corporate bond market.

  7. Recovery of debt: DRTs deal with cases related to debt due to banks and financial institutions. Last year's budget had said that the Government would focus to strengthen the DRTs through computerised processing of court cases. This year, the budget notes that the Government is providing appropriate infrastructure, filling up vacancies and providing training to DRT staff. Recent reports put the Debt Recovery Tribunals (DRTs) case backlog at over 95,000 cases. This year's Budget further note that along with the SARFAESI Act, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 (RDDB & FI Act) has been amended through The Enforcement of Security Interest and Recovery of Debts Laws and Miscellaneous Provisions (Amendment) Act, 2016. This is expected to facilitate expeditious disposal of recovery applications. Harmonisation of provisions of IBC, 2016 with the provisions of the SARFAESI and the RDDB & FI Act is expected to help to improve the credit and recovery environment.

    The Government should prioritise the capacity building efforts at the DRTs. Going forward, based on the Insolvency and bankruptcy Code, 2016 (IBC, 2016), the corporate cases are expected to shift to NCLT. However, the rules and judicial procedures need to be redesigned for both NCLT and DRT to deliver the expected outcomes (Understanding judicial delays in India: Evidence from Debt Recovery Tribunals).

  8. Market for stressed assets: A well function market for stressed assets should encourage a lender sell its NPAs to an Asset Reconstruction Company (ARC). An ARC should be able to raise funds by issuing NPAs backed Security Receipts (SRs). It should then be able to sell the NPAs to redeem the SRs at a profit. This year, the Finance Minister has permitted listing and trading of SRs issued by a securitisation company or a reconstruction company in a registered stock exchange. This is aimed at enhancing capital flows into the securitisation industry and help deal with bank NPAs. This should help efforts to develop the market. Last year's budget proposal to enable the sponsor of an ARC to hold up to 100% stake in the ARC and permit non-institutional investors to invest in SRs have been effected. These have been achieved by amending the SARFAESI Act through The Enforcement of Security Interest and Recovery of Debt Laws and Miscellaneous Provisions (Amendment) Act, 2016 in August 2016.

  9. Mechanism to close down failed financial firms: This year, the Finance Minister has promised to introduce the Bill relating to resolution of financial firms in the current Budget Session. He noted that together with the IBC, 2016, a resolution mechanism for financial firms would ensure comprehensiveness of the resolution system in our country. Last year, the budget had recognised the need for a specialised resolution mechanism to deal with bankruptcy situations in banks, insurance companies and financial sector entities so that losses are minimised. This year's budget notes that the draft law -- The Financial Resolution and Deposit Insurance Bill, 2016 is under vetting by Ministry of Law and Justice (See: Report of Committee to Draft Code on Resolution of Financial Firms). The Insolvency and Bankruptcy Board of India has already been constituted in October 2016. With the above work, the stage is now set for a resolution law. This would lead to creation of a Resolution Corporation (RC).

  10. Taxation: Taxation of finance contains serious problems. The Government needs to re-engage with the task of enabling a simpler direct tax law. The Direct Tax Code Bill of 2009, which promised this, went through several amendments before being finally shelved (Para 129, Budget speech, 2015). The said speech made a case that the Income Tax Act had incorporated most of the suggestions. This assertion is a subject of debate (India still needs the Direct Tax Code, Requiem for a Code). The proposed amendments in this year's Financial Bill related tax administration are retrograde and need to be reconsidered (See: Rai, 2017, Notes on Union Budget 2017-18)

Outside of the above ten areas, the bad loans of the Public Sector Banks (PSBs) present a major concern for the Government. Based on RBI's data table, the net NPAs (gross bad loans less provisions) of nationalised banks and SBI stood at over Rs 3.2 trillion or about 2.4% of GDP at the end of March 2016. The problem of PSBs is an outcome of Government ownership. Unlike PSBs, the NPAs of private sector banks are relatively small at Rs 266.7 billion (7% of the PSBs' figure). RBI's recent Financial Stability Report (FSR, December 2016) forecasts that PSB category may continue to register the highest GNPA ratio (ratio of gross NPA to gross advances). Attempts at reforms are moving rather slowly. The road map for consolidation of banks is being drawn up. However, no specific progress is listed in this year's Budget. The Banking Bureau's job list is expanding but it seems to be struggling with relatively small battles. Last year, the Government had allocated Rs 229 billion for recapitalisation to 13 PSBs. This year, another Rs 100 billion has been budgeted with promise of more. However, over the years, infusing capital has not yielded the desired results.

There is much to look forward to in 2017-18. Most of the reforms seems to be headed in the correct direction. Direct tax administration and the NPA problem of PSBs seem to be the exceptions.


Ashish Aggarwal is a researcher at National Institute of Public Finance and Policy.

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