More supervision needed to deal with uncertainty: Sanyal
NEW DELHI: How should policymakers prepare to deal with challenges in an increasingly uncertain and ever-changing world? In his discussion paper, titled Risk Vs Uncertainty: Supervision, Governance & Skin-in-theGame, principal economic adviser in the finance ministry Sanjeev Sanyal tries to address just that.
Sanyal says in the earlier riskladen world, policymaking was easier as one could lay out the different possibilities that can manifest. “It will either rain tomorrow or it will not rain. In case of uncertainty, like coronavirus, you don’t even know what are the different possibilities. Because we live in an uncertain world, policymaking needs to be tailored to it,” explains K. Subramanian, chief economic adviser in the finance ministry and Sanyal’s boss.
In his discussion paper, Sanyal draws heavily from his past experience in the banking sector and the problems associated with the stringent regulations introduced by the Basel Committee, especially after the global financial crisis of 2007-08. The Basel norms and national regulators prescribe risk weights for bank asset classes and corresponding credit ratings based on which banks calculate the regulatory capital requirements as a share of riskweighted assets.
Sanyal says the “one-size-fitsall” regulatory approach to measure risk and assign risk weights implies reduced “genetic diversity” in the financial system, as banks and regulators around the world fine-tune their business models to assess and manage risk in an identical manner.
“This is dangerous as far from reducing risk, it actually compounds it. This is one major flaw in the entire Basel system as it is based on the idea of risk and not on the idea of uncertainty, whereas we live in an uncertain world. It has made it systemically more risky,” he adds.
REGULATION VS SUPERVISION
So, how does one deal with uncertainty when unintended consequences and random shocks such as geopolitics to epidemics to technological changes are hitting the world with regular intervals? Sanyal says if you want to deal with uncertainty, then you need more supervision, not more regulation. “The usual way we do it is once a bunch of things go wrong, we introduce even more regulations. You are not solving any problem, instead you are creating a complex, rigid system whereas in an uncertain world you need flexibility. What you really want is supervision.”
RULE VS DISCRETION
When pointed out that more supervision may lead to inspector-raj and discretion, Subramanian pitches in: “It’s a rule versus discretion debate!” Subramanian says more broadly, it is actually about building state capacity which is actually critical.
Sanyal explains: “Our default approach in India is to have another law instead of investing in state capacity. That is what we are arguing against. The main point we are making is that rules may even make sense in a risk world; in an uncertain world, it does not make sense,” he adds.