RBI Governor Raghuram Rajan’s recent speech on the Financial Sector Legislative Reforms Commission (FSLRC) started with kind words about it and how its report’s influence “will be felt for many years to come”. However, there are two areas where he has disagreements with it.
The first is on judicial review. He argues that a regulator “fills in the gaps in laws, contracts and even regulations. Not everything the regulator does can be proven in a court of law.” He expresses concerns about tribunals as they lack domain knowledge. He suggests that a “healthy respect for the regulator” keeps participants in line.
Parliament passes laws. The RBI is a creature of the RBI Act. Under the rule of law, the RBI has absolutely no discretion to do things that the RBI Act does not clearly specify in terms of its objectives and powers. For example, if the RBI were to write a regulation forcing banks to not serve beef in their canteens, this is illegal. It is illegal for the RBI to reach beyond the law and do things based on its own assessment of what the “gaps in laws” are. The RBI is not Parliament.
Regulations are written by the RBI. So, if there is a feeling that there is a gap in the regulations, then it is up to the RBI to plug it — as long as its objective and the powers used to achieve the objective are specified in the primary law.
Finally, on judicial review. The Constitution empowers courts to review the work of the legislature and the executive. This is a healthy arrangement. All successful liberal democracies thrive on checks and balances.
Courts routinely go into complex matters. For instance, there is far more intellectual complexity to a biotechnology patent dispute than anything we see in finance. The answer to intellectual complexity is to establish specialised tribunals that amass domain knowledge. This is what the FSLRC proposes.
Liberal democracy is not about a perfect executive interacting with a perfect legislature interacting with a perfect judiciary. Liberal democracy has worked well because checks and balances deliver better results when all three are imperfect. Each of the three wings gets better by grinding against the others. The RBI and the courts are both imperfect. Imperfect judicial review will improve an imperfect RBI, and vice versa. Over the last 20 years, judicial review by an imperfect Securities Appellate Tribunal has strengthened an imperfect Sebi. The RBI has much catching up to do.
I am hostile to “healthy respect for the regulator”. At present, in India, what we have is a feudal environment where regulators lord over practitioners, threaten them, extort from them, and so on. Power corrupts and Indian finance is replete with examples of how things have gone wrong because of “respect” for the regulator. Rajan should be championing the elimination of such misbehaviour.
The second area where Rajan has concerns is the financial regulatory architecture proposed by the FSLRC, which reduces the RBI’s turf. The first principle of natural justice is nemo iudex in causa sua — do not judge your own cause. Rajan should not speak on the size of the RBI’s turf, just as Sebi Chairman U.K. Sinha does not speak about the size of Sebi’s turf.
Within the FSLRC, there were three persons connected with the RBI: Y.H. Malegam (who was a member of the RBI board at the time), K.J. Udeshi (former deputy governor) and P.J. Nayak (practitioner in an industry regulated by the RBI). The RBI’s point of view on its turf was vigorously represented within the FSLRC. Justice B.N. Srikrishna heard all views and hammered out a working compromise.
There are good reasons why the regulation of payments and banking should not be the RBI’s job. But the FSLRC recommended that the RBI do this over and above setting monetary policy. This outcome reflects intense debate and discussion between people who think a lot about these things.
Rajan says that different financial regulatory set-ups have worked in different countries and, therefore, no one set-up is correct for all places. This does not mean that India’s present financial regulatory architecture is correct for it. For the last 20 years, reformers in India have looked towards its backyard and thought about what works and what does not. For example, it’s easy to make an abstract argument that commodity futures should be regulated by the department of consumer affairs — after all, this worked well in the US with the department of agriculture. But in India, reformers advocated moving this function to Sebi 11 years ago. The events at NSEL have proved the reformers right.
Finally, Rajan says we should not establish a clean, coherent, modern law that replaces the existing mess of older laws. We have spent 20 years making minor tweaks, and this hasn’t worked. The economy is doubling every decade or less, and the demands on the financial system are rising rapidly. Scandals, mistreatment of consumers, the crisis of infrastructure financing, the failure of the bond market, bad RBI regulations, etc, all point towards the fact that the current system is broken and that we should fix it.
Countries like the UK, Australia, etc rewrite their financial laws and redesign their regulatory architecture every 30-40 years. In India, we have never done this, even though we are changing at a faster pace. India requires a big move. As with every big move, there is need for great caution and this kind of public debate.
The writer is professor, NIPFP, Delhi