How Independent Are Our Financial Regulators?

following guest post is contributed by Bhargavi
, who is at the National Institute of Public Finance and Policy
(NIPFP), New Delhi. Views are personal.
of this post appeared in the Business Standard]
A sequence
of recent incidents has rekindled the public discourse on the independence of
our financial sector regulators from the Government. Critics of the draft
Indian Financial Code have accused it of
RBI’s wings
. A recent appointment on SEBI’s
was perceived as politicization of the
regulator. These debates raise a larger question of how much independence our financial
regulators enjoy under the current legislative and institutional frameworks
governing them.
Why bother?
Why must
an unelected regulator be independent
of an elected government? Can an elected
government not build technical expertise within itself to regulate specialized
fields? In a democracy, the people elect the legislature to make laws that will
bind them. Doesn’t the “agencification” of
regulation-making diminish the link
between the rule-maker and the electorate that is sought to be regulated? There
are four reasons that underscore the need for regulatory independence.
First, the policy preferences of governments change from time to time.
Often, policy preferences change even with the same government being in power. By
creating an independent regulator, the government builds credibility by foregoing
its decision making powers to a body that will not be influenced by its seasonal
policy preferences (often referred to as the credible commitment theory). Second, the mandate of the regulator and
the means to achieve it may conflict with the temporary incentives of the
government in power. A classic example is the central bank’s mandate to control
inflation that often conflicts with the government’s incentive to pursue economic
growth, which may create an inflationary bias. Third, in an economy where the government runs businesses, the
regulator’s independence from the government is imperative to ensure a level
playing field between public sector undertakings and private sector players. Fourth, independence of the regulator
becomes crucial when taking enforcement actions against the regulated. For
instance, FSSAI’s actions against Maggi must be (or at least perceived to be)
independent of any biases that the government may have against foreign
De facto and de jure independence
of regulators can be classified into formal (or de jure) and informal (or de facto).
The regulatory
independence that is assured under law is formal. A regulator’s formal
independence is reflected in the structure and incentives given to its
management. For example, factors such as the tenure of the regulator’s management
(a longer tenure generally implies greater independence), whether the
management is appointed by a single minister or a more encompassing expert body
(the latter being indicative of higher independence), whether the government
can dismiss the management body, whether the tenure of the management is
renewable, etc. will indicate the extent of a regulator’s formal independence.  Similarly, questions such as the financial
independence of the regulator, that is, whether its overheads are covered by
government grants or fees, whether its decisions can be overturned by the
government, etc. are indicative of the regulator’s formal independence.
do not function in isolation from society. Informal independence of a regulator
refers to the pressures that a regulator is vulnerable to due to its
interaction with other actors in the ecosystem. For example, an appointee’s alignment
with a specific political ideology or the extent to which a regulator is
influenced by the regulated will be factored in its informal independence score.
Independence score
under current frameworks
Under current frameworks, India scores fairly low on de jure independence of her financial
regulators. Laws establishing regulators empower the government to issue
directions to regulators on loose grounds such as public interest and policy. The
power to issue directions to regulators is supplemented with government
nominees on the governing body of the regulator. The selection process for full-time
members of regulatory boards is not institutionalized. The law merely says that
the government will appoint members of the boards of RBI, SEBI and PFRDA. The
rules which provide for a selection committee to make such appointments are
made and can be changed any time, by the government. Within the government,
these appointments go through several files before they are cleared by the
Appointments Committee of the Cabinet. Sometimes, as was done recently for the
appointment of a new SEBI chief, the government issues a public advertisement
inviting applications for the post. Sometimes, the regulator’s management
itself recommends names for selection.
The government enjoys varying levels of power to remove
members of regulatory boards. For example, the government may remove members of
the boards of RBI and SEBI with three months’ notice. These laws do not lay
down specific grounds for removal. Members of the boards of IRDA and PFRDA can,
however, be removed on specific grounds such as abuse of position, insolvency,
It is difficult to assess the informal independence score of regulators, as there are no official
indicators (such as laws or formal structures) of de facto independence. However, the experience so far indicates
that India scores reasonably well on regulators’ de facto independence. For instance, although the law allows the
government to substitute the boards of RBI, SEBI, etc. this power has not been
used till date. Nor has the power to issue directions in public interest been exercised
by the government.
Is there scope for
India’s formal mechanisms leave much to be desired to ensure
that regulatory independence is not threatened. The fact that the executive has
so far not impinged upon regulatory independence through the use of formal
mechanisms is no solace in itself.
The draft Indian Financial Code is a big stride in this
direction. It institutionalizes a formal search and selection committee process
for the appointment of the management of regulators in the primary law itself.
The committee has independent experts and the law sets out a detailed
merit-based selection process. Similarly, the removal of the management is
handled by an independent enquiry committee and the law sets out the specific
grounds for removal. Regulatory agencies are mandated to fund their overheads
from fees generated by them. Finally, the draft IFC does not confer any power
on the government to issue directions to regulators in public interest or on policy.
The recent clamour ignores extant frameworks and continues
to believe in their capacity to protect regulatory independence. An objective
review of existing laws may, perhaps, add perspective on this subject.
– Bhargavi Zaveri

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.

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