The field of financial regulation has traditionally focused on
consumer protection, microprudential regulation and
resolution. However, the 2008 financial crisis highlighted systemic
risk as another important dimension of financial regulatory
governance. Subsequently, governments and lawmakers worldwide have
pursued regulatory strategies to avoid systemic crises and provide for
systemic oversight.
At present, Indian law is silent on the subject of systemic
risk. RBI often implies that it has been doing work on `financial
stability', however at present, there is no legal mandate, no powers,
and no actions.
To some extent, systemic crises are the manifestation of failures
in the core tasks of financial regulation, consumer protection,
micro-prudential regulation and resolution. Proper functioning of
these core tasks, as envisaged in the draft Indian Financial Code,
will reduce systemic risk, but not eliminate it. There is thus a
strong need for a legal strategy for systemic risk regulation. This
has been done for the first time in India in the draft Indian
Financial Code.
You should of course read the
Code and the underlying
in order to help you get a hang of how the FSLRC thinks about
systemic risk, here is a bird's eye view which points you to the
right places in the Code.
We now turn to the sections of the IFC that directly deal with systemic risk:
- S. 2(36), page 3
- introduces the phrase `the Council'
which is used in the IFC to refer to the Financial Stability
and Development Council (FSDC). - S. 2(78), page 7
- defines a `financial system
crisis'. - S. 2(154), page 13
- defines `systemic risk'.
- S. 20, page 19
- sets up the FSDC as a statutory body. A
careful study of the composition of the FSDC in S.21 shows that the
day-to-day functions of the FSDC will be run by a Chief
Executive. There will also be an administrative law member to ensure
that regulatory governance norms are followed. - S.65, page 34
- is an example of the inter-regulatory
co-ordination function of the FSDC. Where two regulators are to take
joint action under the IFC, but are unable to reach a consensus,
they must work with the FSDC to figure out a solution. While
inter-regulatory coordination can be an issue in many contexts
(e.g. SEBI/IRDA on ULIPs), it is certainly a dimension of systemic
risk where the thinking and work cut across all regulators.
- S.141(1)(a)(iii), page 66
- asks that when regulators
such as RBI and UFA are regulating SIFIs, they should take the
relevance of the systemic risk perspective into account. There is no
role for FSDC in what they do here. - S.141(1)(k), page 67
- asks that micro-prudential
regulation should be mindful of systemic risk and particularly
pro-cyclical consequences of regulation. - S.187(1)(c), page 86
- asks that Infrastructure
Institutions (such as exchanges, depositories etc., defined in S.183, page 85) are obliged to promote the
objective of the FSDC to mitigate systemic risk, when they write
bye-laws (which will be approved by the UFA and not FSDC). - S.221, page 96
- sets up the Resolution Corporation at
the level of the entire financial system and details its
objectives. - S.224(1), page 96
- asks that the officers and
employees of the Resolution Corporation have knowledge and
expertise in resolution of SIFIs. - S.287(2), page 121
- asks the Resolution Corporation
to consult with the FSDC where the Resolution Corporation is
contemplating certain resolution measures against a SIFI.
- S.290, page 122
- defines the objectives of FSDC. The
agency will pursue the objective of fostering the stability and
resilience of the financial system by, (a) identifying and
monitoring systemic risk, and (b) taking all required action to
eliminate or mitigate systemic risk. - S.291, page 122
- says that the FSDC consists of its
board, an executive committee, a secretariat and a data centre. Of
particular importance is the data centre, which is defined in
S.294. - S.295, page 123
- sets out the five main activities of
the FSDC. It will study data and do research on the financial
system; it will designate certain financial firms as SIFIs; it will
formulate and implement system-wide measures, it will promote
inter-regulatory cooperation, and it will assist the Ministry of
Finance and all other agencies during a systemic crisis. - S.296, page 123
- establishes principles that must
guide the FSDC. These principles ensure that systemic risk
regulation does not degenerate into achieving the silence of a
graveyard. - S.297, page 123 and 124
- sets forth the analysis and
research objectives of the FSDC. Accordingly, S.298 gives the FSDC
the powers to obtain relevant data. - S.299, page 124
- sets up the legal process through
which the FSDC will determine the criteria to designate certain
financial firms as SIFIs. A financial firm can be adversely affected
when it is designated as a SIFI, hence the full legal process of an
order is required. - S.300, page 125
- sets up the legal process through
which firms would be designated as SIFIs. - S.301, page 125
- asks the FSDC to issue policy
frameworks and regulations for implementing system-wide measures, in
the class of those defined in the Third Schedule (page 185). In the
future, if other system-wide measures are thought useful, Parliament
would have to approve amendments to the Third Schedule to add such
measures. - S.302, page 125 and 126
- sets up the legal process
through which the FSDC will ensure the implementation of system-wide
measures. - S.306, page 127
- asks the FSDC to identify what
parameters it would use to determine a financial system
crisis. S.306(4) asks the Council to assist the Government and
regulatory agencies as specified in S.306(5) (through analysis of
data, providing advice, and assisting in efforts). - S.307 to S.313, page 128 and 129
- constructs the
Financial Data Management Centre (FDMC), a single database about the
entire Indian financial system, which allows the regulators to have
a full picture about the state of the financial system at any point
in time, and particularly during a crisis. As a side effect, the
unification of all supervisory data filings to FDMC also leads to
de-duplication of data and reduces costs for financial firms. This
database is essential for thinking about systemic risk (i.e. about
the overall financial system) and is conspicuously absent in India
today. - S.345 and S.346, page 141
- define the lender of last
resort (LOLR) functions of the central bank. S.345 (temporary
liquidity assistance) relates to assistance given to participants in
the central bank's payment system, and S.346 (ELA) is about lending
against collateral to a more broad class of financial firms. - S.362, page 147
- defines the notion of an emergency,
which can motivate capital controls against inflows under
S.365. Similar provisions for outward flows are specified in
S.368.
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