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Need Active Supervision Instead Of Stringent Regulation, Says Sanjeev Sanyal

India needs active supervision to tackle “unpredictability of uncertainty”, Principal Economic Adviser Sanjeev Sanyal said.

Reeling under tight liquidity conditions, NBFCs and HFCs begin relying on loan sell-downs to banks to raise funds. (Photographer: Dhiraj Singh/Bloomberg)
Reeling under tight liquidity conditions, NBFCs and HFCs begin relying on loan sell-downs to banks to raise funds. (Photographer: Dhiraj Singh/Bloomberg)

India needs active supervision instead of stringent government regulations to tackle the “unpredictability of uncertainty”, according to Principal Economic Adviser Sanjeev Sanyal.

“In uncertainty, it’s difficult to create regulations, and to account for every non-compliant who finds many ways to non-comply,” Sanyal wrote in a discussion paper titled ‘Risk vs Uncertainty: Supervision, Governance & Skin-in-the-Game’. The paper focuses on the need to create rules and regulations to support the compliant rather than penalising the non-compliant.

“It would be far better, therefore, to have a simpler regulatory framework supplemented by active and efficient supervision,” the paper said. “Supervision demands active monitoring and accountability by the government department or regulators that create a perverse incentive to keep adding more top-down regulations regardless of their effectiveness.”

The paper cites the example of tax exemption given to foreign portfolio investors to locate their fund managers in India, however, there are 17 eligibility conditions that these funds have to meet. These stringent conditions are aimed at preventing round-tripping and money laundering, though regulators have money laundering and foreign exchange management related laws in place to counter round-tripping, the paper said. Such stringent regulations have caused several India-related financial services to be rendered from offshore financial centres, the paper said.

Separately, the paper notes that in a complex and interconnected financial system, imposing stringent bank-type regulations on non-bank lenders could either shut off capital to a significant part of the economy or shift systemic risk to another part of the financial system.

“In such a case, only a nuanced regulatory trade-off with active and flexible supervision can be made to work,” the paper said.

The Reserve Bank of India is currently in the process of improving supervision, including risk management and governance at NBFCs, and harmonising the regulations for housing financiers with the NBFC regulations.

Determining Bank Capital Needs

While the regulatory models of banks and regulators aim to account for, and estimate, risk even the most sophisticated models will fail to predict uncertain events—the “unknown unknowns” and “known unknowables”, according to the paper.

This makes it challenging to assess the impact of such uncertainty on bank balance sheets, and therefore correctly measure the “true riskiness” of assets for assigning suitable risk weights.

Hence, the paper argues, a risk weight-based approach to determine bank capital requirements may be misleading when dealing with uncertainty.