Response to Raghuram Rajan's speech on FSLRC

Indian Express, 4 July 2014

Raghuram Rajan's recent speech on FSLRC starts with kind words about FSLRC, and how the report's `influence will be felt for many years to come'. There are three areas where he has disagreements.

Disagreement on judicial review

The first is on judicial review. He argues that regulation `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 the skills. He suggests that a `healthy respect for the regulator' keeps participants in line.

Parliament passes laws. RBI is a creature of the RBI Act. Under the rule of law, RBI has absolutely no discretion on doing things that the RBI Act does not clearly specify in terms of objectives and powers. E.g. if RBI were to write a regulation forcing banks to not serve beef in their canteens, this is illegal. It is illegal for RBI to reach beyond the law, and do things based on its own assessment of `gaps in laws'. RBI is not Parliament.

Regulations are written by RBI, so if there is a feeling that there is a gap, then it is up to RBI to solve that -- as long as the objectives and powers are within those specified in the primary law.

Finally, on judicial review. The Indian Constitution has established the rule of law and the power of the 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. E.g. there is far more intellectual complexity in a patent dispute in biotechnology than anything we see in finance. The answer to intellectual complexity is specialised tribunals that amass specialised knowledge. This is what is proposed by FSLRC.

Liberal democracy is not about a perfect executive interacting with a perfect legislature interacting with a perfect judiciary. Liberal democracy has worked well because the checks and balances deliver better results when all three are imperfect. Each of the three wings gets better by grinding against each other. RBI is highly imperfect and the courts are highly imperfect. Imperfect judicial review will improve the imperfect RBI, and vice versa. Over the last 20 years, judicial review at an imperfect SAT has strengthened an imperfect SEBI. RBI has much catching up to do. Raghu should be leading the way, on learning from the SEBI-SAT experience, and from FSLRC.

I am hostile to the notion of 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. Raghu should be championing the elimination of such misbehaviour.

Disagreement on the role and function of RBI

The second area where Raghu has concerns is the financial regulatory architecture, where he is opposed to FSLRC proposals that reduce RBI turf. The first principle of natural justice is nemo iudex in causa sua: do not judge your own cause. Raghu should not speak on the size of RBI's turf, just as U. K. Sinha does not speak about the size of SEBI's turf.

Within FSLRC, there were three persons connected with RBI: Mr. Malegam (who was a member of the RBI board at the time), Mrs. Udeshi (former deputy governor) and Dr. Nayak (practitioner in an industry regulated by RBI). The RBI point of view on RBI's turf was vigorously represented within FSLRC. Justice Srikrishna heard all views and hammered out a working compromise.

There are good reasons why payments and banking should not be with RBI. But the FLSRC recommendation gave these roles to RBI over and above monetary policy. This outcome reflects intense debate and discussion between people who think a lot about these things.

Raghu says that different financial regulatory architectures have worked in different countries, therefore no one financial regulatory architecture is correct for all places. This does not mean that the present Indian financial regulatory architecture is correct for India. For the last 20 years, reformers in India have looked at our own backyard, and thought about what works and what does not work. E.g. 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 under Indian conditions, 11 years ago, reformers advocated moving this to SEBI. The events at NSEL have proved the reformers right.

Disagreement about fixing the law

Finally, Raghu says we should not do a clean coherent modern law that replaces the existing mess of ancient law. We have spent 20 years doing smaller moves, and this hasn't worked. The economy is doubling every decade or less, and the demands on the financial system are rising rapidly. We have scandals, mistreatment of consumers, a crisis of infrastructure financing, failure on the bond market, bad RBI regulations, etc. It's broken, and we should fix it.

Countries like the UK, Australia, etc. do a full rewrite of their financial law and regulatory architecture every 30-40 years. In India, we have never done this, even though our rate of change is higher. India requires a big move. As with every big move, there is a need for great caution, and this kind of public debate.

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