The World Bank and IMF may have a point about regulatory gaps in India’s financial sector

In the aftermath of the 2008 financial crisis, both the Bank and IMF have jointly started undertaking a comprehensive study of the financial sector in select countries, especially those with systemically important financial sectors. The study is mandatory every five years in 32 select countries, including India. The joint exercise is called Financial Sector Assessment Program, with both the multilateral institutions coming out with their individual reports.

The Bank’s report states that India’s financial system has become more resilient, diversified and inclusive. It states: “Total financial sector assets reached 187% of GDP, with non-banking financial institutions and market financing growing at a much faster pace than banks, accounting for 44% of financial sector assets in 2024 (compared to 35% in 2017)…Stress tests suggest that credit institutions are broadly resilient to macro-financial shocks, despite some weak tails.”

A press release issued by the financial stability division in the department of economic affairs, finance ministry, has welcomed the Bank’s latest assessment. But there is a catch here. A reading of this press release gives no idea of the concerns that both multilateral institutions have raised over the regulatory gaps. To be fair, the Indian authorities have responded to many other concerns and defended the government’s stand on some specific issues, but seem to have side-stepped specific apprehensions over regulatory gaps.

The first concern raised is the regulators’ lack of power and independence which the multilateral institutions want strengthened through legislative and institutional changes.

The Bank cites a specific case from 2019 when the finance ministry overturned a Reserve Bank of India (RBI) decision to cancel the licence of an urban cooperative bank. The Bank calls the finance ministry an appellate authority with powers to overturn RBI’s supervisory decisions and recommends that this appellate authority should be transferred to an independent agency.

The Bank, through a footnote, starkly describes the control that the finance ministry wields over RBI and other regulatory agencies: “The MoF is represented in the RBI board. The government can remove the governor, deputy governor, and directors without justification; give directions to the RBI; supersede its board; request an inspection of banks; and exempt banks from applying for the [Banking Regulation] Act, among others. The government can remove the insurance regulator’s chair and the members of its board and appoint an insurance comptroller.”

Strangely, the many impassioned appeals for ending RBI’s untrammelled powers by appointing quasi-judicial appellate authorities—especially from those seeking increased centralisation of powers in Delhi—never mention the curious case of the finance ministry’s unitary powers.

The other regulatory gap that finds mention is the differentiated regulatory framework applicable to private and state-owned financial institutions. RBI’s extensive regulatory powers over private bank boards or their key management personnel do not apply to boards of public sector banks. Many of the state-owned institutions are guided by their respective Acts, which is also an inhibiting factor for regulation.

In addition, unlike its powers over private sector banks, RBI has limited powers to force a merger of weak public sector banks, vet and approve appointment of their individual board members, sack their board members or even supersede their boards. Both the Bank and IMF are echoing repeated domestic concerns about a regulatory framework which affords leniency to public sector institutions over private players, an allowance granted to ostensibly enable the delivery of developmental objectives.

A special mention has been made about state-owned infrastructure financing non-banking financial companies (NBFCs) which are overweight on power and infrastructure loans and therefore pose a systemic risk to the financial sector. The Bank has questioned the logic of the country’s top three NBFCs, which also happen to be state-owned, being exempted from the stringent rules applicable to the top category.

Eyebrows have also been raised about the supervision and regulation of financial conglomerates which have multiple businesses and, thus, report to different regulators. Unfortunately, the inter-regulator platform—the Financial Stability Development Council (FSDC)—lacks any legal teeth to undertake group-level supervision or enforce regulatory action. It has been in existence for a while but its policies, activities or regulatory outcomes are shrouded in secrecy.

There have been demands for some time now to make FSDC’s deliberations public. While RBI’s bi-annual Financial Stability Report purports to reflect FSDC’s collective assessment about the Indian financial system’s resilience and risks to financial stability, it lacks specifics about where the risks originated and how they were mitigated.

The author is a senior journalist and author of ‘Slip, Stitch and Stumble: The Untold Story of India’s Financial Sector Reforms’ @rajrishisinghal