Opinion
RBI’s new regulatory framework relies on significant self-policing
Summary
- The broad goal is to not only enable early risk recognition and mitigation but also reduce the regulatory burden for everyone.
Shaktikanta Das, Reserve Bank of India (RBI) governor, deviated from his prepared speech while delivering the keynote address at Mint’s recent BFSI Summit and provided a couple of interesting asides. The governor’s office, he said, had been encouraging one-on-one discussions with bank chief executives and a spirit of free exchange had allowed RBI to pick up industry trends that would have otherwise reached the central bank much later. Consequently, the central bank’s regulatory actions were occasionally based on such inputs. Das also mentioned in passing that many bankers had been complaining to him about the ever-increasing RBI-imposed regulatory and compliance burden.
These two digressions, taken in conjunction with his speech, provide pointers to the central bank’s evolving regulatory architecture. Specifically, Governor Das’s stewardship is attempting to make regulation functional at two elementary levels: encourage self-regulation at both the entity level and industry level. The understanding is that since both the entity and industry collective have more knowledge and information than the regulator, pre-emptive actions at these stages will be more timely and effective. Both, though, might need some rethinking and reformatting.
RBI’s focused attention on action at the first level is evident from Das’s past refrains about the corporate governance gap in banks and non-banking financial companies (NBFCs). This theme was evident even at the BFSI Summit. If, by and large, banks are able to tighten their governance hatches and keep the information pipeline between senior management and board members open, there is a possibility that the board-level committees will be able to stave off emergent risks and crises. However, the prospects get a bit skewed in public sector banks where loyalty is divided because the government hand-picks both senior management and board members and RBI is left wielding residual moral authority. There is, therefore, little incentive in state-owned banks to improve governance structures and processes on issues relating to regulation.
Financial institutions also have to contend with problems that afflict board-level committees—such as risk management or internal audit, responsible for safeguarding shareholder interests—in non-financial companies. For one, in many private banks, the chairman and chief executive decide appointments to these committees, creating an inherent conflict of interest and sowing seeds of possible prejudicial outcomes. Another organizational problem is a topsy-turvy incentive structure, with the marketing and business origination teams accorded priority over the teams in assurance functions, such as risk management.
The second level of regulation finds expression in RBI’s attempts to promote self-regulatory organizations (SROs) for each industry vertical—one each for banks, NBFCs, fintech firms, among others. The central bank has also published a draft omnibus framework for recognizing SROs across all regulated verticals and invited stakeholder inputs before finalizing an operational version. But the draft framework has some gaps—specifically with relation to an existing SRO, as well as emerging SROs—which may need closure before norms are finalized.
The draft framework may have to close the organizational gaps in the financial services industry’s only functioning SRO: the Indian Banks’ Association (IBA). Even though it lacks the teeth to be an effective SRO, the IBA is considered an SRO only by default because it has been around for over 75 years.
The IBA is seen more as a representative of public sector banks, with only a passing nod reserved for private and foreign banks. In fact, some foreign banks even constituted a parallel body during the early 1990s (which was wound up soon thereafter) because they felt that the IBA did not adequately represent their interests. Over the years, the IBA’s primary function has been reduced to conducting wage negotiations with public sector bank employees (State Bank of India, however, conducts its own wage talks). The IBA is also responsible for implementing some RBI regulations by drafting rules and agreements. The central bank may have to revisit its framework to make IBA fit for purpose.
The second problem lies in the emerging fintech lending industry. The 2021 report of a working group on digital lending had recommended the setting up of an SRO for this industry. The working group had also recommended that the government take similar action for digital lending business carried out by entities which are not regulated by RBI. But the fintech lending industry is split down the middle with effectively two SROs—the Digital Lending Association of India and the Fintech Association for Consumer Empowerment— calling the shots and essentially competing with each other. The presence of multiple SROs presents an opportunity for regulatory arbitrage and compliance shopping. The RBI framework on SROs is silent on this aspect, but will have to eventually evolve some norms for selecting a single industry-wide SRO.
RBI’s new regulatory architecture is a work-in-progress. It is focused on making regulation a community effort which aims to not only enable early risk recognition and mitigation, but also reduce the regulatory burden for both RBI and regulated entities. It will be interesting to see what other columns, arches or balustrades RBI adds to its existing super-structure.
