The Need for Clarity in the Revised IFC

Six new financial agencies with no clear mandates – the draft Indian Financial Code has to be redrafted to reduce the number of conflicting agencies and give clearer mandates to any new agency it will create.

The draft Indian Financial Code has been in the limelight since the time the Finance Ministry put it online and welcomed comments. The main criticism against the code is that it substantially weakens the Reserve Bank of India, by taking away many of its existing powers. More specifically, the substantial part of the criticism is directed against the Monetary Policy Committee (MPC), the composition of its members and what it would imply for the conducting of monetary policy in India. The MPC, according to the draft IFC, will contain seven members, of which four will be selected by the Central Government and three from the RBI. This obviously fosters fear of transferring monetary policy powers from the RBI to the government, because of the majority in MPC held by the latter.

While the brouhaha over the MPC is justified, it is preventing adequate attention to be given to other aspects of the draft IFC that deserves it. One of the principal, yet flawed recommendations of the IFC is the creation of a seven-agency structure for the financial sector — the Reserve Bank of India (RBI), Unified Financial Agency (UFA), Financial Sector Appellate Tribunal (FSAT), Resolution Corporation (RC), Financial Redressal Agency (FRA), Financial Stability and Development Council (FSDC) and Public Debt Management Agency (PDMA).

The RBI currently manages the functions that are designated to these agencies, namely monetary policy, financial stability, banking regulation, regulation of non-banking financial institutions, forex management, deposit insurance and credit guarantee and payment and settlement systems. However, after the creation of the six other agencies, the RBI will be partially in charge of monetary policy (via the MPC), banking regulation and only systematically important payment and settlement systems.

The creation of the Redressal and Resolution agencies, which are independent, have some merit, as their mandate is to protect consumers. However, other agencies and their functions are contentious as there is very little clarity over their exact mandates.

The six new financial agencies and the RBI with conflicting mandates will be fighting for control over the steering wheel. Illustration by C.R Sasikumar. Source:

The six new financial agencies and the RBI with conflicting mandates will be fighting for control over the steering wheel.

Banking regulation has been, fortunately, left with the RBI. However, the Unified Financial Agency has been given the regulatory power over all non-banking financial institutions (NBFCs) and payment systems. This could include segments of the markets such as securities, commodities, NBFCs, Micro Finance Institutions, insurance, etc. Separating banking regulation (with RBI) from that of other, non-bank credit institutions (with UFA) will create many possibilities of regulatory arbitrage, and could lead to financial instability.

Looking at the Public Debt Management Agency (PDMA), the mandate is to make the market for government securities liquid and to keep the costs of borrowing down. It is clear then that the PDMA will strive to keep the rates down through participation in the G-Sec markets. This will severely hamper RBI’s operations in the secondary markets through its Open Market Operations (OMO). The PDMA will have seven members, of which four will be chosen by an expert selection committee (who chooses these members?), and one each from the RBI, central government and the state governments in turn.  Envisage a situation where the government has accumulated large amounts of public debt, which has increased the cost of borrowing and the rate of inflation. The two main instruments of the RBI to fight this scenario are through control over the policy rate and through open market operations. However, in the new system, the MPC may not allow an increase in the policy rate and any RBI OMO operations will be dominated by actions of the PDMA.

The Financial Stability and Development Council has the mandate to evaluate and manage the systemic risks in the financial system. This functioning is closely linked and inalienable to the function of regulation of the banking system, which lies with the RBI. How does the IFC imagine the FSDC to manage and mitigate systemic risks without having the power to regulate the banking sector?

Each of these agencies will have different mandates and views, which might conflict with the other agencies. Further, each agency will have members belonging to the government, RBI, or independent experts, who will try to pursue their own agenda. It should also be remembered that there already exists a host of other regulatory bodies in the financial space: SEBI, FMC, IRDA, PFRDA, NABARD, etc. How will the actions of all of these financial agencies be coordinated to pursue a higher agenda of financial stability, price stability and long term sustainable growth?

Finally, a surprising omission from the draft IFC is the control over exchange rates. As it is well known, the exchange rate of the Indian rupee is not entirely determined by the market forces. The RBI intervenes from time to time to either reduce volatility (stated mandate) or to maintain the exchange rate at ‘comfortable levels’ (unstated). An exchange rate policy cannot be independent of monetary policy and forex management. Then, will the MPC be in charge of exchange rate management as well? If so, it can create all sorts of distortions in the economy. The government may try to have a ‘strong’ currency out of a misplaced sense of pride.

The Financial code will have to be redrafted to reduce the number of conflicting agencies and give clearer mandates to any new agency it will create. Finally, it will need to look at the justification behind its attempt to fix a system that is not broken and not tinker with the well functioning aspects of the financial system.

Image Source:       Illustration by C.R Sasikumar.

Anupam Manur is a Policy Analyst at the Takshashila Institution. He tweets @anupammanur