Empirical research shows that better developed financial systems accelerate economic growth and shrink income inequality by disproportionately increasing the earnings of lower income families i.e. enabling growth with equity, which is so vital for our country.
A well developed financial system will require sound legislative framework because, legislation is the foundation on which institutional frameworks stand. To be effective, legislation not only needs to be unambiguous and fair but also should be robust enough to address all the existing concerns while, at the same time, being flexible enough to accommodate the new needs on account of evolving environment.
Role of legislation in the context of economic development in general and the financial sector in particular, is an interesting area of study. It has been argued that strong legal systems foster development of sophisticated financial markets and intermediaries, which enhances the economy's ability to manage risk and eventually lead to economic growth. Measures such as robust contract enforcement and disclosure discipline go a long way in strengthening the financial systems. India is said to be one the most over-legislated countries. We have numerous Acts and regulations, some of which date back decades. As times have changed quite significantly since they were enacted, there is an emphatic need to update and fine tune them so as to enhance their relevance for the rapidly changing financial landscape. It is a welcome step that FSLRC has been constituted to look into and revise the existing financial legislation. In this context, the role of this Congress is very important in facilitating deliberations.
The Road Ahead: Legislative Reforms in the Banking Sector
There is a strong case for reviewing Banking Regulation Act, 1949 and State Co-operative Societies Acts and recasting them for a number of reasons. First, prudential regulations are ownership neutral. However, the fact that different banks are governed by different laws has resulted in an uneven playing field which needs to be addressed. For example, while amendments were carried out to enable SBI, SBI subsidiary banks and nationalised banks to issue preference shares, though at different points of time, banks in private sector cannot issue preference shares as the amendments to the BR Act is still to be carried out.
Similarly, while bilateral netting in the event of liquidation is admissible for private sector banks governed by the Companies Act and the normal bankruptcy laws, the position in this regard for public sector banks, SBI and its subsidiaries is not clear in law, as liquidation, if at all, of such banks would be as per the Notification to be issued by the Government in this regard. Second, a single, harmonized and uniform legislation applicable to all banks will provide transparency, comprehensiveness and clarity and provide ease of regulation and supervision to the Reserve Bank.
Third, there is also a need to sort out the conflicts and overlaps between the primary laws governing the banking sector and other applicable laws. For example, the Competition Act, 2002 (as amended by the Competition (Amendment) Act, 2007) is in conflict with the provisions of the Banking Regulation Act, SBI Act and other statutes dealing with the amalgamation of banks. Consolidation of banking sector laws and laying down of common regulatory framework for commercial banks are issues requiring serious consideration.
Management of Banks
Management of banking institutions by fit and proper persons plays an important role in securing the safety of banks. While RBI has power, under certain circumstances, to remove the managerial and other persons from the banks and appoint additional directors, etc., these powers may not be effective in handling a situation where supersession of the Board is warranted. RBI, currently, does not have the power to supersede the Board of Directors of a banking company. In the Banking Laws Amendment Bill, 2011 amendments are being proposed for conferring such a power on RBI, for being used with appropriate safeguards.
With respect to public sector banks, by way of amendments, similar powers have been vested in the Central Government, which has the majority shareholding in those banks.
The shareholding pattern also plays a vital role with respect to the management of banks and, therefore, it is necessary that shareholders having sizeable holding should also be fit and proper. RBI has, by way of regulatory prescriptions, implemented an acknowledgement procedure. In the 2011 Bill, statutory provisions are being proposed for obtaining prior permission of RBI for acquiring 5% or more of the equity shares or voting rights in a banking company. At present, a deadlock situation arises if a group of persons acquires sizeable equity or voting rights in a bank without following the acknowledgement procedure. There is no statutory power for directing disgorgement of shares and as such, if any such acquisition takes place, it may result only in contravention in provisions of BR Act. The main object of preventing the management of a bank from being captured by persons who are not fit and proper for holding such sizeable interest will not be achieved. RBI should, therefore, have the power to direct, by order, at any time that persons who are not fit and proper to hold such equity or voting power in contravention of these provisions, shall not have voting power. The 2011 Bill proposes to confer such power on RBI. This will help prevent unscrupulous persons from exercising control over banks.
Deposit Collection Activity
Currently, collection of deposits from members/shareholders is not treated as acceptance of public deposits. This is a matter of serious concern, particularly, with respect to Co-operative Societies. Deposits are accepted by enrolling members on tap and by collecting nominal amounts from them, exposing such depositors to serious risks. Banking Regulation Act does not apply to such co-operative societies and they are outside the regulatory purview of the Reserve Bank. It is necessary to plug this important loophole. Unless deposits are received from members who have voting rights, the deposits have to be treated as public deposits and the exemption from the provisions of Banking Regulation Act should not be made applicable. Every entity that accepts deposits from persons having no voting rights has to be treated as deposit accepting entity and should be regulated as such by RBI.
RBI should have the discretion to determine the level and intensity of regulation and supervision depending upon the risk to the system from such entities.
Financial Conglomerates
In India, banks are entitled to carry on certain financial activities under the bank subsidiary model. Some banks have formed subsidiaries to carry on securities and insurance business. The performance of the subsidiaries affects the balance sheet of the bank. On account of varied activities carried on by the entities in the group which fall within the regulatory jurisdiction of multiple regulators, the risk to the system as a whole posed by such financial conglomerates is difficult to assess. These raise systemic issues and RBI as the regulator of banks needs to be empowered to obtain information, with respect to each of the entities functioning under the umbrella of a bank. The 2011 Bill proposes to confer such powers on RBI to get information with respect to such entities. This ought to be pursued in the new legislative framework also.
Anand Sinha
(It is the abridged version of the address by Anand Sinha, Deputy Governor, Reserve Bank of India at Financial Planning Congress'11 organised by Financial Planning Standards Board of India at Mumbai recently. The full version could be accessed from www.rbi.org.in )
