The meltdown of IL&FS and DHFL suggests that regulators need better systems to keep pace with market ingenuity
The success of the liberalisation of the markets is underwritten by the efficacy of regulatory oversight. A deficit can seriously imperil the rhythm of the market, prejudice the interests of participants and derail the primary objective of using resources more efficiently. The oft-cited definition of regulation refers to “sustained and focussed control exercised by a public agency over activities that are valued by a community” (Selznick). The underpinning of control is to influence and shape the conduct of the participants.
The global integration of markets, blurring of boundaries between segments, explosion of information technology, emergence of new tools and techniques et al are metamorphosing the dynamics of the marketplace.
The profit motive is the primary purpose of participation in the market. Participants visualise the future. They work overtime to harness every information, (information asymmetry, in particular), opportunity and regulatory kink from which they can profit.
The alacrity of regulatory bodies is always on test. Neither do the extant laws and regulations capture the emerging dynamics nor are enforcement mechanisms potent enough to handle shaping technologies and growing innovations. The contemporary regulatory framework is unlikely to cope with the new setting.
The regulatory framework has to be evolutionary. The evolution has to be driven by constant analysis of transaction data and behavioural patterns. Such an analysis has to be complemented by the anticipation of likely events.
Simply put, a moving target cannot be successfully chased with static or periodically changing positions.
The ingenuity of the market has to be matched by a constantly growing regulatory capacity, which can be summed up as the power to make and enforce rules leading to intended effects, acceptable conduct, and desirable outcomes.
Recent unfortunate events such as the meltdown of IL&FS, DHFL, HDIL, PMC, Karvy, etc., are leading — albeit vicariously — to the building of angst on regulatory efficacy. There is no evidence to doubt the earnestness and commitment of the regulatory authorities. The competencies of individuals are not under question either.
These events appear to suggest that markets are running ahead of the regulatory capacity. The contemporary regulatory designs appear to be failing across geographies; of course, in different segments of different jurisdictions.
Unfortunately, our regulatory designs are significantly influenced by those of the developed markets. Even though, all the financial regulators have their exclusive academic institutions — RBI-NIBM, IGRD & CAFRAL; SEBI-NSIM; IRDA-IRM&R — enough research is not being done to help the respective regulators in building capacity and customising the framework.
In a democracy, where political and economic decision-making is driven by social issues, knee-jerk reactions become increasingly likely; and in defence, regulators tend to go overboard and, at times, issue orders which further erode the rhythm of the market and hurt the participants.
It is well understood that sometimes, regulators have to act in a hurry without the support of data analysis and academic review. However, post facto moves to identify and treat the disease should be organised, rather than continuing to treat the symptom, which may eventually hurt in the long run.
Regulatory capacity building has not received as much significance as the actual regulation of the markets. The RBI recently announced the creation of a separate cadre for the regulation of banks, NBFCs and HFCs. While such moves do help in creating additional bandwidth, the regulatory capacity deficiency may continue to persist in the absence of a holistic approach.
Regulatory capacity building warrants periodical assessment with a three-pillar approach. The first pillar is the framework of coverage and the flexibility and ease of extending the coverage.
The second pillar is the maintenance processes. And the third is the implementation mechanism. An ever-increasing number of participants, growing volume of transactions and changing behaviour itself make today’s weaponry ineffective tomorrow.
The regulatory bodies broadly suffer from: deficiencies of the authority to frame laws, inadequate organisational design, insufficient financial resources, and limited information.
While authority delegation, organisation redesign and adequacy of financial resources can be navigated with the state’s support, the challenge of information asymmetry warrants ‘networking relationships’ of key officials with regulated entities.
Such relationships flower only when there are resource inter-dependencies, and without an exchange of full and appropriate information, such relationships do not deliver.
Well-organised and widely-represented effective self-regulatory bodies help in formulating network relationships. Unfortunately, for a variety of reasons, the concept of self-regulatory bodies has been a non-starter in India. Some regulatory bodies in India are wary of sharing even an inch of the regulatory space, even though they are conscious of their own inadequacy.
The other method of building network relationships is direct interactions with the market participants and innovators of products, processes and technologies.
Unfortunately, the key regulatory officials have been shy of building bridges of relationships with the target audience and their interactions have been limited to events and ceremonies in purely formal roles of delivering inaugural addresses and keynote speeches. The ‘network relationship’ building with the regulated entities is viewed with suspicion.
The solution lies in coordination amongst regulators, academicians, regulatees and innovators. The regulators ought to introduce academic thinking in the shaping of policies as the RBI does with extensive in-house research in the area of macroeconomics. The creation of a research wing within the regulatory framework would certainly help.
Further, the anonymous cold market data should be freely available to academic institutions, think tanks and individual researchers to discern emerging trends and their likely impacts.
Such an approach is missing in India. Consequently, none of the think tanks or academic institutions are doing significant work in the area. It is a happy augury that a young regulator — IBBI — has been on its feet to constantly revisit and evolve the framework and has even set up a committee to design a framework to assess the outcomes.
There is an urgent need to build an eco-system of building regulatory capacity, which is currently missing in India.
The writer is former chairman, SEBI and LIC