INDIAN FINANCIAL MARKETS: EVOLUTION OF A DIALECTIC REGULATORY MODEL

Abstract

Existence and growth of financial markets is very essential for the growth of any economy. Distortions and malpractices in the functioning of these markets, if unchecked in time, may sooner or later spell doom for the whole economy. In recent times, the financial sectors in most countries around the world have undergone major changes. Deregulation, liberalisation, technological and financial innovations, emergence of financial conglomerates, gradual disappearance of traditional frontiers separating banking, securities and insurance domains from each other, growing competitive conditions, mergers, etc. are the predominant features of financial markets in most countries. The need for an effective financial regulatory system is today greater than ever before. A debate is already under-way as regards the nature of changes that are desirable. Some countries are adopting fully integrated, singleregulator agency system while others are opting for partly integrated, or multiple regulatory agencies system. The effectiveness of these models is yet to be established. Whatever the merit of contentions put forward in the debate, the fact remains that no model how so elegantly it may have been designed is necessarily the right path for all countries to tread upon. The specific circumstances of a country and its experiences with various regulatory initiatives in the past together with cognizance of relevant critical issues play a crucial role in the designing of an effective regulatory model. The issue of desirability of a shift in the regulatory structure has been analysed in the present study using the broad dialectic analytic frame. The analysis is based on the perceptions of a sample group of regulators, financial intermediaries and investors regarding deficiencies in the present regulatory set-up and the need for a change in the same. Regression analysis, within the broad dialectic analytic frame, constitutes the core of research methodology. IV The required data have been generated by addressing a well-designed questionnaire to a select sample group of 210 respondents who are participants in the financial markets in one way or other - regulators, financial intermediaries and investors (including academics). As such, the study is a cross-sectional perception analysis. The issues included for exposing to the respondents for ascertaining their views and suggestions mainly relate to (a) objectives of financial regulation and relevance of regulatory structure to the same; (b) deficiencies of the existing financial regulatory system and their significance as determinants and explicators of change in the system; (c) arguments for and against a structural change in the present regulatory system; and (d) determinants of effectiveness of financial regulation. Protecting the economy against systemic risk, creating and sustaining fair markets, and prevention of financial crimes have been viewed as 'highly important' objectives of financial regulation by an impressive majority of respondents, in each category. They mostly believe that the dominant position of the Ministry of Finance and RBI, lack of communication and co-ordination, and overlapping areas of jurisdiction of various regulators constitute the most predominant grey areas in the existing regulatory system. A substantial majority of respondents belonging to the categories of Financial Intermediaries and Investors is in favour of unified regulation. In sharp contrast to this, amongthe Regulators only a few of them are in favour of integration of existing multiple sectoral regulators. But 'lead' model has been revealed to be the rallying point for most of the respondents holding extreme positions in this regard. Respondents mostly share the view that the RBI's domain of role needs to be seriously reviewed. The RBI is believed to be over-burdened due to its twin roles of acting as monetary authority and government's banker which may not only dilute latter's banking sector supervisory role but also have the potential of conflicting with each other. Lastly, for the effectiveness of regulation, the respondents suggest proper mechanism for ensuring communication and coordination among regulators, optimalmix of externally imposed regulation and the market-generated regulation, costbenefit analysis of new regulatory initiatives, and regulatory bench-marking,. Making use of inputs received from respondents and employing the analytic frame of linear regression, an attempt has been made to 'predict' the broad structural form of a financial regulatory model which may be expected to emerge, in due course, as a natural consequence of interaction of diverse forces presently operating in the system. The main objective of regression analysis is to ascertain if there is any discernible and significant pattern in the perceptions of different groups of present regulatory system in terms of its objectives and deficiencies, and the need for change or no change in the same. The regression results point out to a regulatory model which structurally lies somewhere between a partly unified / 'lead' model, at the one extreme, and a fully unified model (outside the RBI), on the other extreme. One may see this model as the consensus model which may be expected to meet the challengesthrown by the rapidly growing and complex modern financial markets. The model highlights the need for ensuring communication and coordination among regulators as the most important requirement for effectiveness of regulation. Views may differ whether this is achievable within the present regulatory set-up or an alternative one. The converging view-point on this issue rallies around the need for departure from the existing model in favour of a unified model, and at least the 'lead' model, immediately. The thrust of the findings of the present study is in favour of adoption of at least the 'lead' model (with lead outside the RBI) presently, and a shift in the direction of structural unification, ultimately. Also, the evidence from the study does not substantiate the presence of any coherent, valid and reliable relationship between the importance of vi various objectives of financial regulation, on the one side, and the desirability of structural unification, on the other. Ultimately, what really matters is the effectiveness of regulation, rather than the form of regulatory structure. Unified regulation is one of the several options. Many factors play an important role in the determination of the regulatory regime, which a country needs to adopt. A regulatory regime must be such that it satisfies the environment in which it is to be implemented; it must take complete cognizance of the business activities of the regulated financial institutions and the specific circumstances of the country.