Towards a more robust financial services architecture
A probabilistic, performance-based approach is required to future-proof regulation and the technologies deployed.
An aspirant India needs all its sectors to be transforming, especially financial sector, which is the most leveraged of all. This sector requires capacity building to grow entrepreneurship while managing risks. Despite improvements, and notwithstanding visible improvements in the payment systems, India continues to be underbanked, underinsured and inadequately covered by old age income security measures.
Viewed from global best practices, India has ratcheted up a policy framework that over-emphasizes compliance at the expense of competition, outcome and innovation in financial services. The financial regulation in India is fragmented and rule-based. It is (over) prescriptive. Experts paint a picture of the fiscalisation of the banking infrastructure with inherent conflicts involving the state owning the banks that control about three-fourths of total banking assets in India. The government ownership of Public Sector Banks (PSBS) hinders the ability of Reserve Bank of India (RBI) to regulate the sector, according to a report by the National Council of Applied Economic Research (NCAER). The underperformance of PSBS has persisted despite a number of policy initiatives aimed at bolstering their performance including recapitalization, the constitution of the Bank Board Bureau to streamline and professionalize hiring and governance practices, prompt corrective action plans, and consolidation through mergers. NCAER makes the case that the Centre should privatise all PSBS, except the State Bank of India (SBI).
Financial stability and innovation are not contradictory; the regulatory barriers between banks, non-banks, and fintech must be overcome; and the regulatory administration in terms of process, technology, and human capital needs to be more nuanced. Apart from the health of PSBS, the extent of commercial finance should provide a sobering corrective. One also needs organized arrangements for non-corporate enterprises and households. Also needed are domestic venture funds, to fund MSME vendors and technology or business-model-driven startups in manufacturing and in socially desirable activities like education, health, and environmental management.
In most major economies, bond-market volumes far exceed those of equity. The Insolvency and Bankruptcy Code (IBC) has started but is mired in long-winding processes, and legal calisthenics. Regulation technology (Regtech) is becoming increasingly important for compliance and risk management. A probabilistic, performance-based approach—entertaining the evolution of new economic or social scenarios, new technologies and new business models—is required to future-proof regulation and the technologies deployed. Moreover, financial inclusion is a critical issue. This necessitates continued push to the digital economy with an enabling e-commerce ecosystem, and the adaptation of laws and institutions to the digital revolution in areas such as competition policy, regulatory regimes, innovation ecosystems, workforce development, social protection frameworks, and tax policies.
India’s insurance penetration, an infrastructure, is far below the global average. This requires a collaborative framework that insists on total insurance penetration, led by a vision that embraces inclusion and champions reforms to encourage enterprise to serve and strengthen the macroeconomic objectives. The Government’s reformative agenda as an owner must include all PSU insurance companies become world-class insurance providers. The approach via “divestment” as part of a grand transformation story should be clear to all (a year after the listing of Life Insurance Corporation [LIC], the investors are scrambling for cover as its stock is now trading, down 40% from the IPO price and 35% from the listing price. The story of “New India” and “GIC Re” stocks is more embarrassing to recount.) Instead, the approach to privatization goes via empowerment first. It is important to recall China efforts: The Chinese government has ensured that the government-owned Chinese insurance companies, as professionally managed entities, become vital cogs running the wheels of Chinese economy and further its strategic interests—all in a decade’s time. By prioritizing disaster risk financing, India can lead in promoting awareness of the financial impact of disasters, and also establish a regulatory framework to enhance the financial capacity of insurance companies to cover disaster losses, manage climate risks and build resilient economy and society.
Pension sector reforms in India were initiated with the OASIS (Old Age Social and Income Security) report of 1999. In 2004, the government formally moved to the National Pension Scheme (NPS). NPS is now regulated under the Pension Fund Regulatory and Development Authority (PFRDA) Act 2013 and is a defined contributory pension scheme. All Indian states should agree that efforts to return to the pay-asyou-go (PAYG) have serious fiscal sustainability implications. The OPS (Old Pension Scheme) states would end up spending 2/3rd of their own revenues on pensions by 2046/47, with very few resources left for development.
The International Financial Services Centers (IFSC) require high-level human capital specialized in finance, particularly quantitative finance; state-of-the-art IT systems; trading platforms; a well-developed, sophisticated, open financial system; a complete array of proficient, liquid markets in all segments; and absence of protectionist barriers and discriminatory policies favouring domestic over foreign financial firms in providing financial services. The experiences with leading global centers have demonstrated that there is a cluster effect of all related professional services attracted by commercially-viable trading and regulatory regimes along with high-quality and stable institutional environments. Mumbai, which has the largest financial ecosystem in India, must be worked at as India’s global financial services center, with symbiotic linkages to IFSC at GIFT City, Hyderabad and Delhi. This will also help India become a Global Reinsurance Hub, under discussion since 2011 (Forty-first Report of Standing Committee on Finance).
Finally, the 21st century financial services must have a transforming policy framework: a) Principle-based primary legislations that align the objectives across related streams, prudently avoid being overly specific, empowers regulators with adequate powers to grow and supervise the market through secondary legislations/regulations; b) An empowered regulatory setup that supervises through principle-based regulations which are credible, responsible and proportionate, in line with global best practices. The financial services, with inclusion and prudence as anchor values, require a reengineered framework— fulcrummed on competition, specialism, innovation and a level-playing field that is prepared to offer maximum governance. This task was facilitated through Financial Sector Legislative Reforms Commission (FSLRC) to comprehensively review and redraw the legislation governing India’s financial system. According to the FSLRC, the current regulatory structure is fragmented and fraught with regulatory gaps, overlaps, inconsistencies and arbitrage. To address this, FSLRC suggested a draft Indian Financial Code (IFC) to replace the bulk of the existing financial laws. The draft code is a non-sectoral, principle-based law bringing together laws governing different sectors of the financial system. The draft Code seeks to move away from the current sector-wise regulation to a system where the RBI regulates the banking and payments system. A Unified Financial Agency subsumes existing regulators like Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority of India (IRDAI), PFRDA, International Financial Services
Centers Authority (IFSCA) and Forward Markets Commission (FMC) to regulate the rest of the financial markets. (However, there must be differential focuses on “prudential” regulatory requirements and “conduct” issues.) IFC also envisages a seller-beware market. The RBI is relieved of its public debt management role. “Solutioning” should replace the current “supply paradigm”, and TECHFIN must be geared up along with Web 3.0. which would necessitate financial regulators to build a framework for the “future of finance”. Environment, Social and Governance (ESG), anyway, demands higher attention and regulatory scrutiny.
Historically, finance has always been international in character. The financial architecture, with financial inclusion as its archetype, must raise state capacity beyond borders, and go full hog. It requires whole-of-the government approach, and a committed political capital.
A former CEO, and recipient of Lifetime Achievement Award at the 24th Asia Insurance Industry Awards, 2020 Singapore, Arun Agarwal has been publishing research papers, and has recently edited and authored (along with others) a book, “Time for Bharat”, which raises educated conversations on public governance, in an encompassing way.