CORPORATE FINANCE

COMPREHENSIVE ANALYSIS OF THE FINANCIAL

SECTOR LEGISLATIVE REFORMS COMMISSION
Introduction
The Financial Sector Legislative Reforms Commission (FSLRC) was constituted by the
Ministry of Finance in March 2011. Finance Minister announced the formation of the
Commission in his budget speech of 2011-12. He stated that this step was much needed as the
institutional framework governing the financial sector of India was framed over a century ago.
The Commission was made with an aim to review and redraw the legislations which govern
the financial system of India. The chairperson of the Commission was Justice B.N. Srikrishna,
who is a former judge of Supreme Court of India. As per the FSLRC, the current regulatory
mechanism is very disjointed and is filled with regulatory gaps, overlaps, inconsistencies and
arbitrage. In order to address this, the Commission turned in its report to the Ministry of Finance
on 23 March 2013. This report contained an analysis of the existing regulatory framework and
a draft of Indian Financial Code for the modern financial sector in lines with the aspirations of
the resurgent Indian economy to replace the existing legislation.

Broadly, recommendations of the FSLRC can be divided into two parts,

1. Legislative aspects - The legislative recommendations relate to re-writing the laws

using a principle-based approach, restructuring existing regulatory agencies and
creating new agencies. Implementation of these recommendations would require wider
consultations with stakeholders.
2. Non-legislative aspects - The non-legislative aspects of the recommendations are
relating to governance enhancing measures on consumer protection and greater
transparency in the functioning of financial sector regulators. And the same has been
accepted and is being implemented by all regulators on a voluntary basis.

The basic approach of the FSLRC is to provide clear mandate and powers and mechanism for
accountability to financial agencies. The tasks are consumer protection, prudential regulation,
resolution mechanism, capital controls, systematic risk, financial inclusion and market
development, and monetary policy which need to be addressed in a non-sectoral manner.

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Terms of Reference and Objectives
The Terms of Reference of the Commission include the following:

1. Examining the architecture of the legislative and regulatory system governing the
Financial sector in India
2. Examine if legislation should mandate statement of principles of legislative intent
behind every piece of subordinate legislation in order to make the purposive intent of
the legislation clear and transparent to users of the law and to the Courts.
3. Examine if public feedback for draft subordinate legislation should be made mandatory,
with exception for emergency measures.
4. Examine prescription of parameters for invocation of emergency powers where
regulatory action may be taken on ex parte basis.
5. Examine the interplay of exchange controls under FEMA and FDI Policy with other
regulatory regimes within the financial sector.
6. Examine the most appropriate means of oversight over regulators and their autonomy
from government.
7. Examine the need for re-statement of the law and immediate repeal of any out-dated
legislation on the basis of judicial decisions and policy shifts in the last two decades of
the financial sector post-liberalisation.
8. Examination of issues of data privacy and protection of consumer of financial services
in the Indian market.
9. Examination of legislation relating to the role of information technology in the delivery
of financial services in India, and their effectiveness.
10. Examination of all recommendations already made by various expert committees set
up by the government and by regulators and to implement measures that can be easily
accepted.
11. Examine the role of state governments and legislatures in ensuring a smooth interstate
financial services infrastructure in India.
12. Examination of any other related issues.

Working Groups
Owing to the scope and depth of research needed to complete this project, certain sectors were
selected and dedicated Working Groups (WG) were formulated for in depth analysis. These

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Working Groups consisted of experts from that sector who created their own report with
relevant recommendations. The following Working Groups were formed:

1. WG on Banking
2. WG on Insurance, Pensions and Small Savings
3. WG on Payments
4. WG on Public Debt Management
5. WG on Securities

Proposed architecture
The FSLRC recommended a model of the proposed regulatory architecture which is a seven-
agency structure for the financial sector. In short, the seven pillars of the new law suggested by
FSLRC are:

1. Reserve Bank of India: Regulator of Banking & Payments monetary policy.

2. Unified Financial Agency: Regulator of financial firms and activities other than
banking and payments.
3. Resolution Corporation: Deals with closure of distress in firms.
4. Financial Redressal Agency (FRA): Single window complaint mechanism against
financial institutions and intermediaries.
5. Financial Stability & Development Council: Recast as statutory body. Will manage
systematic risks and development.
6. Public Debt Management Agency: Government’s debt manager.
7. Financial Sector Appellate Tribunal (FSAT): Will hear complaints against all financial
regulators. The Financial Sector Appellate Tribunal (FSAT) was suggested to be
formed. It will subsume the Securities Appellate Tribunal. Its function will be to hear
appeals against regulatory functions of Reserve Bank of India, the Unified Financial
Agency (UFA), decisions of the Financial Redressal Agency and some elements of the
work of the Resolution Corporation.

It is proposed that RBI will perform three functions:

1. monetary policy,
2. regulation and supervision of banking in enforcing the proposed consumer protection
law and the proposed micro-prudential law, and
3. regulation and supervision of payment systems in enforcing these two laws

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In order to develop specialised skills and minimise conflicts, Commission recommended that
these three functions should be performed by separate boards each overseeing work relating to
their field only.

The Draft Indian Financial Code

The draft is a non-sectoral and principal-based law as it brings together laws governing
different sectors of the financial system. The draft addresses the following components, which
the Committee believes every financial legal framework should address:

1. Consumer Protection – The draft Code lays down certain basic rights for all financial
consumers and suggested the formation of a unified regulator called the Unified
Financial Agency (UFA) to serve any aggrieved consumers across sectors. UFA upon
acquiring the required experience, is to be merged with the Reserve Bank of India
(RBI). This UFA will subsume the Securities and Exchange Board of India (SEBI), the
Insurance Regulatory and Development Authority (IRDA), the Pension Fund
Regulatory and Development Authority (PFRDA) and the Forward Markets
Commission (FMC). The Commission suggested that RBI will retain the power to
enforce laws of the banking sector and monetary policy. The FSLRC deems that
competition is an important aspect of consumer protection and lays down a detailed
mechanism for cooperation among the regulators and the Competition Commission.
2. Micro-prudential regulation – Commission suggested that the regulators should
monitor financial firms and try to reduce the probability of failure of a financial firm.
The Code specifies five powers for micro-prudential regulation which are:
a. Regulation of entry
b. Regulation of risk-taking
c. Regulation of loss absorption
d. Regulation of governance and management
e. Monitoring or supervision.
3. Resolution – The Code suggested formation of a unified resolution corporation which
will deal with financial firms and intervene when the firm is about to close due to
failure. It will provide service on a fee basis which will be based on the probability of
its failure.
4. Capital Controls – The Commission said that the capital controls, if any, should be
implemented in sound footing with respect to public administration and law. The
Commission views the formation of rules for inbound capital flows by the Ministry of

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 Finance and the formation of regulations for outbound capital flows by the RBI and the
implementation of all capital flows by the RBI.
5. Systemic Risk – The Commission envisages establishment of Financial and Stability
and Development Council (FSDC) as a statutory agency to take leadership in the role
of minimizing systemic risk. It will undertake interventions to reduce risk in the
financial system.
6. Development and redistribution - The responsibility of regulator will be undertaken by
the developing market infrastructure and process. And the Ministry of Finance will look
at the redistribution policies.
7. Monetary policy – A quantitative target will be laid down by Ministry of Finance which
will be monitored by the RBI with various tools to pursue this target. An executive
Monetary Policy Committee (MPC) will be established to choose on how would RBI
exercise its powers.
8. Public debt management – A specialised framework is given in the draft for
management of public debt with a strategy of low-cost financing. The Commission
proposes a single agency to manage government debt.
9. Contacts, trading and market abuse – The draft lays down the legal foundation for
contracts, property and securities market.

Regulatory Governance
Now with respect to the Regulators in the market, the Commission suggests independence and
accountability to be established when it comes to regulation and firms. The draft adopts
neutrality as it does not differentiate between the regulatory and supervisory treatment of a
public financial firm or a private financial firm. The regulators are:

1. Reserve Bank of India for regulating the banking and payments system, and
2. Unified Financial Agency (UFA) to perform functions of SEBI, IRDA, PFRDA and FMC.

The regulators will have an empowered board with precisely selected members. The members
will be selected by a selection-cum-search process. The members of regulatory board can be
divided into 4 categories:

1. Chairperson
2. Executive members
3. Non-executive members
4. Government nominee.

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In addition to this, there will be a general framework for the purpose of establishing advisory
councils whose function will be to support the board. All regulatory agencies will be funded
completely by the fees charged to the financial system.

Independence of Regulators

The arguments provided by FSLRC in favour of independence of regulators are:

1. The regulator is allowed to set up a specialised workforce that has superior technical
knowledge.

2. It is assisted by modified human resource and other processes, when compared with the
functioning of mainstream government departments.
3. With such knowledge, and close observation of the industry, an independent regulator
is able to move rapidly in modifying regulations, thus giving malleability to laws.
4. The presence of independent regulators improves legal certainty.
The Commission also stated that there is a need to separate the adjudication function of the
regulator from its mainstream activities in order to achieve greater separation of powers. It
pressed upon the independence of the regulators since the government holds the power to issue
directions to the regulators. So, the Commission proposed for this power of the government to
be removed.

At the same time, independence cannot be given to an agency in isolation. Parliament should
not delegate power to unelected officials without adequate accountability mechanisms. New
channels of accountability need to be constructed as independent agencies are not subject to
accountability through elections.

Accountability of regulators

But independence is not an unmixed blessing: when unelected officials are given power, this
needs to be accompanied by accountability mechanisms. FSLRC will pursue all four ways to
establish accountability:

1. Avoid conflicting objectives - desirable to structure regulatory bodies with clarity of

purpose and the absence of conflicting objectives.
2. A well-structured rule-making process: A well-structured rule-making process will
introduce checks and balances that will avoid suboptimal outcomes. To ensure that
the regulations are not more convenient for the regulator rather than the larger national

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 interest and that the benefits of the regulations outweigh the costs, for every regulation
there should be:
a. A statement of the objects and reasons of the subordinate legislation;
b. A description of the market outcome which is an inefficient one;
c. Demonstration that solving this market failure is within the objectives of the
regulator;
d. Clear and precise exposition of the proposed intervention;
e. Demonstration that the proposed intervention is within the powers of the regulator;
f. Demonstration that the proposed intervention would address the identified market
failure;
g. Demonstration that the costs to society through complying with the intervention are
outweighed by the gains to society from addressing the market failure.
3. The rule of law - The Commission believes that a formal and transparent system of
regulation, rooted in the rule of law, encourages entry of new financial service providers
and thereby reduces costs and financial exclusion. It focusses on core principles of rule
of law, which are:
a. Laws should be known before an action takes place.
b. Laws should be applied uniformly across similar situations.
c. Every application of law should provide the private party with the information for
application of the law, the reasoning by which the conclusion was arrived at, and a
mechanism for appeal.
4. Reporting: Once the objectives of an agency have been defined, it is meaningful to ask
the agency to report the extent to which it has achieved these objectives. Each agency
should report on how it has fared on pursuing its desired outcomes, and at what cost.

Criticism
Although the plenty of responses received on release of the FSLRC Approach Paper were
positive, it gathered some strong criticisms too.

Unified Financial Agency

With respect to unified financial agency (UFA) as a single entity to regulate all financial firms
except banks for consumer protection and micro-prudential requirements, the reasons given for
criticism are:

1. Regulatory monopoly

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 2. Lack of requisite skill sets
3. International records of other countries demonstrate failure of such agency
4. Different sectors require different expertise and specialisation. A single regulator will
not be able to maintain such broad spectrum of work load.
5. Two decades of empowerment of financial regulators is sought to be reversed with this
report.
6. Creating a statutory body called the Financial Stability and Development Council
(FSDC), which will sit over the regulators, would further take away the independence
and expertise of regulators, is regressive and deeply disturbing.
7. There is no internal consistency of reducing the number of regulators to reduce
regulatory arbitrage.
8. Principles based law sounds good in theory.
Reserve Bank of India

The proposal of FSLRC to reduce some powers of RBI and redefining its objectives was met
with certain criticism. One criticism is that the role of RBI restricted to stabilising prices is
wrong, as RBI has various roles to play other than just focus on maintaining stability in prices.

Another criticism is to monetary policy coordination by RBI only during emergency situations.
It should not be so. As managing debt is a complex task. It requires coordination of the
monetary policy as well as the fiscal policy and thus RBI is ideally suited to tackle the situation.
Other criticisms

1. The changes are so drastic that they will never get implemented.
2. The Commission has over stepped its mandate. Instead of strengthening and improving
the existing laws, they have tried too hard to overhaul the entire system.
3. The report is detached from reality.