The Genesis & Rationale of the Inter-regulatory Working Group

The financial sector in India has undergone significant liberalisation in all the four segments - banking, non-banking finance, securities and insurance and each of these sectors has grown significantly accompanied by a process of restructuring among the market intermediaries. This has refined market micro structure, modernised operations, and broadened investment choices unleashing competition among the intermediaries, who are restructuring themselves for their survival and growth. The financial landscape is increasingly witnessing -

1. entry of some of the bigger banks into other financial segments like merchant banking, insurance, etc. which has made them financial 'conglomerates';

2. emergence of several new players with diversified presence across major segments and

3. possibility of some of the non-banking institutions in the financial sector acquiring large enough proportions to have a systemic impact.

From a regulatory perspective, above developments have led to an appreciation of the limitations of the segmental approach to supervision in addressing the following potential risks associated with conglomeration :

1. The moral hazard associated with the 'Too-Big-To-Fail' position of many financial conglomerates;

2. Contagion or reputation effects on account of the 'holding out' phenomenon;

3. Concerns about regulatory arbitrage, non-arm's length dealings, etc. arising out of Intra-group Transactions and Exposures (ITEs) both financial and non-financial.

As a proactive stance to address these concerns and also to further consolidate the gains on financial stability, the Governor, Reserve Bank of India (RBI) had announced in the Mid-term Review of Monetary and Credit Policy for the year 2003-04 about the decision taken in consultation with the Chairman, Securities and Exchange Board of India (SEBI) and Chairman, Insurance Regulatory and Development Authority (IRDA) for establishment of a special monitoring system for Systemically Important Financial Intermediaries (SIFIs).

Accordingly, an inter-regulatory Working Group had been constituted with members drawn from RBI (Smt. Shyamala Gopinath, Convenor), SEBI (Shri M.S.Sahoo) and IRDA (Shri Prabodh Chander). The working Group was mandated to propose a list of SIFIs based on set criteria and advise on a monitoring/reporting system encompassing the following:

1. a reporting system for SIFIs on financial matters of common interest to RBI, SEBI and IRDA;

2. the reporting of intra-group transactions of a Financial Conglomerate; and

3. the exchange of relevant information among RBI, SEBI and IRDA.

During the course of deliberations the group recognised that there are systemically important institutions, which do not have sectoral linkages and are supervised by a financial regulator. Given the terms of reference the Group, therefore, decided to focus on "Financial Conglomerate" having cross-sectoral presence. Financial Conglomerate is also a term internationally used, commonly understood and well defined.

The Group has finalised its recommendations after extensive deliberations. It submitted its Report on June 14, 2004. The Report of the Working Group is organized in five chapters. After the introduction in Chapter I, Chapter II gives a conceptual background including the practices being adopted internationally by other regulators/supervisors in this regard and the present status in India regarding implementation of consolidated supervision. Chapter III elaborates on the issues addressed by the Working Group and the details of the contours of the framework being proposed while Chapter IV explains the operational aspects in regard to the proposed framework. The next chapter benchmarks the supervisory framework, as existing currently as well as the proposed mechanism, against the Principles of Intra-Group Transactions and Exposures suggested by the Joint Forum, Bank for International settlement (BIS). The gist of the observations and recommendations of the working Group are discussed in the following articles.