Delhi,not Mumbai

Somebody has been paying attention. Even as informed opinion around the world following the financial crisis comes to the agreement that the most important,as well as the most urgent,remedial task was to address macro-prudential risk,the Budget revealed that India would set up a new super-regulator,the Financial Stability and Development Council,to deal with precisely that risk. Such a body is essential because macro-prudential risk is too endemic to be left to a maze of less-than-super regulators,to a skein of regulations. Current systems fail at regulating or even spotting macro-prudential risk for two reasons. First,because the inter-connectedness of finance is not reflected in the silos and jurisdictional walls that grow up when there are several regulators who dont talk to each other enough leading,for example,to problems beneath each individual regulators notice that nevertheless are systemically destabilising. Second,because that same inter-connectedness also creates firms that get too embedded to fail without undermining the system. A many-regulator system will not be able to keep them in rein,or to fix their problems in time.

Thats why the new council is necessary. And reports that it will be chaired by the finance minister are also welcome. Some have claimed that the proper location for any such apex regulator is within the Reserve Bank of India with the corollary that it be chaired by the governor of the RBI. This is unwise on several levels,and makes little sense both theoretically and practically.

Yes,monetary theorists have demonstrated that central bank independence is essential for a stable currency policy; but microeconomic theory and basic commonsense assures us that putting one party the RBI,the banking regulator in charge of mediating conflicts between regulators is a very bad idea. And on a more fundamental level,remember any super-regulator might have to advise bailouts with taxpayer money: a decision that can and should be nothing but political,subject to the scrutiny of the Cabinet,and accountable to Parliament. Hoping that this decision could be depoliticised and professional would require us to rewrite the eighteen-month political history of the financial crisis. The new committee should supercede the current informal committee,which the RBI governor leads,and which can fail dramatically if relations between regulators break down as they are wont to do. We need a formal structure looking at macro risk,one that ensures people talk and headed by the FM. History,theory,and common sense show that anything else would be a mistake.