Need for Regulatory Balance

Source-This post on Need for Regulatory Balance has been created based on the article “Maintaining regulatory balance” published in “Business Standards” on 15 July 2024.

UPSC Syllabus – GS Paper 3 – Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment

Context– The article stresses the need for balanced bank regulation to protect both depositors and investors. While regulators are often conservative and risk-averse, banks need operational flexibility to compete and innovate.

Why is there a need for a differentiated regulatory framework for banks?

Banks operate with high leverage ratios, accept public deposits, and rely on central bank support as lenders of last resort. This necessitates a specialized regulatory framework to ensure stability and trust in the banking system.

What are the challenges in regulation of banks?

1) RBI’s Control Over Private-Sector Banks – The RBI strictly regulates private-sector banks by approving board appointments, tenures, and salaries, often rejecting candidates or changing recommendations

2) Credibility Crisis – Seven of the top 10 private-sector banks by market capitalization have chairpersons who are former RBI officials or civil servants. This creates a board structure like public-sector banks. Such close ties can lead to moral hazard, making it difficult for regulators to maintain independence in challenging situations. This process may even risk the credibility of banks.

3) Lack of Concern for Investors Interest-

A) Many listed banks do not provide complete or timely disclosures, leaving investors uninformed about their true situation.

B) If the regulator acts suddenly against a bank, investors may be left confused. The RBI often doesn’t provide clear explanations, making it hard for investors to understand what’s happening.

C) The ₹8,400 crore litigation over AT-1 bonds issued by YES Bank, written off by the RBI’s administrator, exposes problems with the bond structure that prioritize equity over debt holders. This goes against standard financial principles.

Read More- RBI Surplus Transfer to Government

What should be the way forward?

1) The RBI should reconsider its appointment policy and limit its role to appointing chairpersons and directors only for systemically important banks.

2) RBI should improve transparency in its regulatory actions to better serve all stakeholders in the banking sector.

3) AT-1 bonds should be restructured so that they are written down only after wiping out common equity Tier-I capital.

Question for practice

What are the challenges in regulation of banks?