Banking Sector Reforms

[op-ed snap] Does India need a financial policy committee?

 Note4students

Mains Paper 3: Economy | Mobilization of resources

From UPSC perspective, the following things are important:

Prelims level: London Inter-bank Offered Rate (Libor), Financial Policy Committee, Banking Regulation Act (1949), Financial stability and development council (FSDC),

Mains level: Risks associated with the banking sector in India and need for specialized committees to separate banking and finance roles


Context

Diversified banking problems

  1. Varied kinds of banking and finance problems seem to be spreading around the world
  2. There has been London Inter-bank Offered Rate (Libor) fraud, Bank of Italy officials are grappling with non-performing assets problems in their economy
  3. India’s central bank governor has highlighted that the Reserve Bank of India (RBI) needs more powers to regulate ailing public sector banks

The idea of Financial Policy Committee (FPC)

  1. What is the FPC? It’s mandate was to look at the financial sector in a holistic manner and assess macroprudential risks
  2. It was instituted in the UK in the wake of 2008 financial crisis
  3. FPC is a 12-member committee with diverse representation from the Bank of England, Financial Conduct Authority, private sector and academia
  4. The committee meets four times a year and releases its flagship financial stability report twice in those meetings
  5. Just like India’s monetary policy committee sets interest rates, the FPC sets the countercyclical capital buffer rate, which basically tweaks the capital requirements for banks
  6. If the FPC sees that risks could be high in the future, it asks banks to increase its capital ratio
  7. It also analyses debt of households and firms and takes suitable measures

Institutional measures in India

  1. India already has some institutional arrangements that require reporting on the financial sector
  2. The Banking Regulation Act (1949) mandates that the RBI release an annual report, “Trend And Progress Of Banking In India”
  3. The RBI also started the “Report On Currency And Finance”, which was not mandatory but nevertheless gave us an overview of developments in the financial sector
  4. In its monetary policy decisions, the RBI also releases a document on regulation developments, which contains proposed changes in banking regulations
  5. The government established a financial stability and development council (FSDC) to bring greater coordination among financial market regulators
  6. In 2010, the RBI also started releasing its biannual “Financial Stability Report” (FSR), which has become the flagship report

Will these measures suffice?

  1. Given how financial markets and activities have become increasingly interconnected, they might not
  2. It is only a matter of time before problems in Indian financial markets start to resemble those in the West
  3. India is poised to have its own sub-prime moment in the near future

What can be done?

  1. The alternative is to appoint a new FPC and reallocate the finance-related decisions, responsibilities and publications to it
  2. The MPC can focus on macroeconomics and interest rates
  3. FPC and MPC would have common members like the RBI governor and deputy governors but FPC would have more specialists in the domain of finance

Way Forward

  1. Finance has become heavily specialized and interconnected in recent years and warrants attention from specialists
  2. We may not be able to prevent a future financial crisis but can at least try mitigating its damaging effects
  3. FPC could be one of the ways to achieve this
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