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Monday, September 23, 2013

Low-hanging fruits for Rajan to pluck
Protection of consumers of financial services and regulation of NBFCs would give a major leg-up to financial sector reforms
Reserve Bank of India (RBI) Governor Raghuram Rajan has spoken (September 4). In an extraordinary piece of first public articulation of views by a central bank governor, the much-dreaded F-word in the corridors of the Reserve Bank of India ("FSLRC" - the Financial Sector Legislative Reform Commission) was uttered twice. First, about strengthening the monetary policy mechanism, and next, about the resolution mechanism set out in the Indian Financial Code drafted by the FSLRC. Some other areas Rajan highlighted as his focus areas were also hot subjects in the Indian Financial Code (IFC): financial inclusion, dealing with directed priority sector lending, bank licensing, and electronic payments systems.

Acknowledging the IFC's existence is a big milestone. Public commentary about RBI and FSLRC after IFC was published evidenced deep-seated distrust. Hardliners on each side of the divide refused to engage on the contents of the IFC - it has been a George Bush-like you-are-either-with-us-or-against-us approach, with just the divide seeming to matter so much that what the divide was about remained immaterial. With Rajan's opening line, a possible change in the quality of discourse is showing promisingly positive signs. Many a column has been written already about the Governor's speech, ranging from appearances (both visual, and on his policy approach) to the regulatory signals he has sent. Some even credit the rupee's recovery to this one speech.

This edition of the column does not intend to analyse the speech further. This was written before Governor Rajan's first formal policy statement that would have been made by the time this is printed. This piece is rather about two simple but important areas that RBI would do well acknowledge and deal with, using legal and regulatory powers it already has. It would not need Parliament to legislate anything. Not being matters of independence in monetary policy, no aspect of dogma or faith need be addressed. The first affects the man on the street, and the second affects businessmen making investments.

First, Rajan could easily pick up for implementation, the draft provisions in IFC that govern protection of consumers of financial services. IFC has provisions that define what would constitute an unfair term in a non-negotiated contract for provision of financial services. The factors set out for determination of what is a non-negotiated contract and what in it would be an unfair term, could easily be prescribed by RBI using its existing powers under the Banking Regulation Act. Unfair conduct, abusive conduct, consumer data privacy, and fair disclosure norms, have all been provided for in IFC and RBI can easily adopt these under subordinate legislation, and regulate this core area of activity in its role as a regulator. Implementing these measures and swiftly making use of the first few violations as opportunities to articulate RBI's thought process and expectations would be a simple way to give this important area of financial sector reform a major leg-up.

Second, the area of non-banking financial companies (NBFCs) needs urgent attention. Today, RBI is increasingly assertive about this part of its turf, and rightly so. Financial firms that otherwise do what banks can do (borrow from the public, either directly or from banks that borrow from the public, and lend to the public) indeed need to be effectively regulated. RBI Act, which required every such company to register with the RBI and conform to special requirements, sustained a constitutional challenge. If the rule of law has any majesty, these provisions indeed need to be implemented and enforced.

However, somewhere down the line, the RBI lost sight of the need for a clearly-stated policy on dealing with NBFCs. An unstated policy of not granting any more NBFC licences got developed, thereby placing an abnormal premium on existing NBFC licences. Transitional provisions for entities that are NBFCs seeking registration are sorely lacking. When a company meets the requirements necessary for registration as an NBFC, and applies for one, RBI should simply grant it with appropriate and well-reasoned restrictions and conditions. Today, companies with thousands of crores of financial assets that want to be registered as NBFCs are simply told they would be prosecuted if they undertake further NBFC activity, without any indication on whether a registration would indeed be granted. A policy for penalising past defaults and registration for future activity is sorely lacking. Rajan would do well to pick this up for a clean-up. 

Courtesy: The Business Standard