Legal Risks and Financial Sector; Capital Controls

Recent developments in the financial sector have witnessed a sea-change in the nature of legal risks faced by banks and financial institutions. Regulators, banks and financial institutions, as well as their legal advisors (both in-house and external) are required to constantly keep pace with the change. In that context, a recent speech by Shyamala Gopinath, Deputy Governor of the Reserve Bank of India (RBI), contains an interesting account of the legal risks in the present environment, and the steps taken by the RBI to address those risks. The issues highlighted range from those relating to OTC derivatives, enforcement of security arrangements, and the effectiveness of bankruptcy laws (including from a cross-border perspective). While some of the issues carry international implications and have been highlighted due to the financial crisis, others are specific to India.

On a separate note, the Economist has a column that deals with capital controls in emerging economies. Commenting on RBI’s policy, it observes that it is difficult to argue against capital controls, especially given the Indian economy’s resilience in the wake of the global financial crisis: “Having avoided the Asian financial crisis in the 1990s and escaped the worst effects of the most recent meltdown, India’s cautious liberalisers feel they have won the argument this time around. It is hard to disagree.”

The column also describes the undue complexity of India’s capital control regime:

For starters, they are needlessly complex, because India’s policymakers like to retain as much room for manoeuvre as possible. They police capital flows by banning some trades, imposing quotas on others, lifting a price control here or tightening a registration requirement there. This makes life needlessly difficult for foreign investors. The rules are hard to interpret and changes are impossible to predict. One private-equity fund and its investors reckon this confusion and ambiguity cost them $8m in lawyers’ fees. This accomplishes the policymakers’ aim of deterring foreign capital, but not quite in the way they intended. By raising the cost of doing business, the regulatory thicket acts as an implicit tax on investing in India. Its policymakers could achieve the same effect through simple rules and explicit taxes. The $8m that is now spent on lawyers could be given to the Indian government instead.

There is certainly a case for simplification of various rules relating to capital flows. More importantly, the rules ought to be clear with very little left for interpretation.

See also a related report in the Economist.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

1 comment

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