Draft Report of the High Level Group on Services Sector

6.3 The next level of change: A new approach to the financial sector

India has an aspiration of rapid economic growth to become one of the world’s leading economies. The financial sector must have the capacity to support and partner in this growth. In this context it is necessary to examine what needs to be done to take the financial sector to the next level, as a means to propel India on its growth trajectory.

The approach to development and regulation of the financial sector in India has been one of segmentation. Each aspect of financial services is required to be conducted by a separate legal entity, independently licensed and regulated, generally by a separate regulator, and having varying restrictions on the nature and size of shareholding. There are restrictions on undertaking complementary activities and on sharing information and infrastructure. In the context of the evolution of the financial sector, there is a need to examine whether this is the optimal structure for the future growth of the sector. The current architecture prevents the efficient utilization of systemic capital, infrastructure, including distribution and back-office infrastructure, and skills, including asset management, credit and investment decision-making and risk management. It thus increases the cost of financial intermediation and the cost of purchase of financial products and services to the customer, and constrains financial inclusion. It makes Indian financial sector players smaller and less competitive than global counterparts. It also creates opportunities for regulatory arbitrage, with differently regulated entities offering essentially the same product with widely different regulatory controls and capital requirements. Finally, it forces the customer to segment his or her purchase of financial products and services between various providers, and creates greater complexity in understanding the essence and cost of the product or service being delivered.
Going forward, it would be appropriate to consider a holistic rather than a segmented approach towards the financial sector. This would involve the following key steps:

1. 
   Enabling the formation of financial services holding companies;
   
2. 
   Elimination of anomalous differences in the ownership regulations for various segments of the financial sector, with a bias towards freeing up ownership restrictions to the greatest possible extent;
   
3. 
   Sharing of distribution and “back-end” infrastructure, including a review of the current prohibition against assigning asset management activity by insurers to asset managers, among financial service providers; and
   
4. 
   Move towards a single regulator for financial services, as opposed to the current multiplicity of regulators for different segments.
   

It is widely accepted that financial sector regulation must evolve with the changes in the financial sector and the market dynamics. The Indian financial sector has evolved significantly since liberalization, and now possesses a fair degree of resilience and ability to meet the requirements of economic growth going forward. This is due indeed in large part to the initiatives of regulators and policy makers over the past decade. The initiatives of private sector participation, inflow of international capital and calibrated expansion of products and services have been successful. There is a need now for rapidly embracing innovation in order to meet the needs of various customer segments and achieving global competitiveness. There is therefore a need to consider a shift from a “rules-based” regulatory framework that is prescriptive and focused on controlling the financial sector, to a “principles-based” approach that encourages innovation and growth, within an overall framework of financial stability.