Consultative Regulation-Making that Should Go Further

Recently, the Reserve Bank of India (RBI) issued a policy framework detailing its procedure for publishing regulations, directions, guidelines, and notifications.

Role of Regulators in India’s Economy

• Economic Umpires: Regulators function as “umpires in economic fields,” ensuring fair play and adherence to rules.
  • RBI (Reserve Bank of India) acts as the “bank referee,” overseeing the banking sector. SEBI (Securities and Exchange Board of India) regulates markets, primarily the securities market.
• Statutory Basis: Both RBI and SEBI are created under Acts of Parliament, making them statutory bodies. They derive their rule-making power directly from Parliament.
• Delegated Legislation: This conferral of rule-making authority by Parliament to these bodies is known as ‘Delegated Legislation’.

Quasi-Legislative Powers and the Rule of Law

• Quasi Legislative: Quasi” means “almost,” and “Legislative” means “law-making.” This term describes bodies that, while not Parliament, act similarly by making rules.
• Framework: Regulators exercise this power by making day-to-day rules within a broader legal framework established by Parliament.
• Potential for Misuse: Such significant power can be misused if not subject to proper checks.
• Upholding the Rule of Law: The principle of the ‘Rule of Law’ ensures that all exercise of power, including rule-making, follows established procedures and legal frameworks, thereby preventing arbitrary actions and promoting accountability.
• Welcome Start: The recently published frameworks, outlining procedures for law-making by RBI and SEBI, are seen as a welcome start.

Key Features of the New Regulatory Processes

• Impact Analyses (RBI): When proposing new regulations or amendments, the RBI will now conduct “impact analyses.”
• Objectives (SEBI): SEBI, for its part, will state the “regulatory intent and objectives” of its proposals.
• Public Comments: Both regulators will now invite public comments for 21 days.
• Periodic Review: A significant reform is that they will also periodically review their own regulations.

Two Key Additions Proposed

• Clear Economic Rationale: Regulators should clearly identify the economic rationale for their interventions.
• Accountability Mechanisms: They should institute mechanisms to ensure accountability for periodic reviews and responses to public comments.

Understanding Market Failure

• Core Concept: Market failure occurs “When markets can’t self-regulate efficiently.” Examples: Common instances include:
  • Information Asymmetry: Where one party in a transaction has more or better information than the other (e.g., in financial markets).
  • Monopoly: A single entity controls the market, leading to lack of competition and potentially higher prices or lower quality.
  • Pollution: Negative externalities where production or consumption imposes costs on third parties not involved in the transaction.

Solution to Market Failure

• Targeted Intervention: Regulations are designed to fix specific, diagnosed issues arising from market failures.
  • Example: SEBI’s Insider Trading Rule: SEBI’s rule against insider trading directly addresses information asymmetry in the stock market, ensuring fair play.
• FSLRC Emphasis (2013): The Financial Sector Legislative Reforms Commission (FSLRC) emphasized that “laws must be defined in terms of their economic purpose.”

International Best Practices

• United States: Executive memoranda mandate regulators to undertake cost-benefit analysis, ensure “least burden on society,” maximize benefits, and assess alternatives to direct regulation.
• European Union: The Better Regulation Framework requires impact assessments to identify the problem, potential solutions and their impact, and mechanisms for monitoring and evaluation.

Challenge in Regulatory Reforms

• Limited State Capacity: A significant hurdle to effective regulatory reform is “Limited State Capacity,” primarily stemming from a lack of expert staff.
• Lack of Expertise: Implementing crucial regulatory practices, such as cost-benefit analyses, specifically requires professionals like economists and data scientists.
  • Most regulators currently lack such internal capacity to conduct these complex analyses effectively
• Poor Track Record Pre-2025: The history of public consultation by regulators was poor prior to 2025.
• Limited RBI Consultation: The Reserve Bank of India (RBI) sought public comments on only 2.4% of its circulars.
• SEBI’s Insufficient Engagement: The Securities and Exchange Board of India (SEBI) engaged in public consultation for less than half of its regulations.

Way Forward

• Clarity: Regulatory drafts should clearly define the market failure that necessitates intervention.
• Explaining the Solution: The draft must explicitly state how the proposed rule addresses this identified market failure. This establishes a direct link between the problem and the solution.
• Analysis: Regulators should show cost-benefit data and societal impact of the proposed regulation.
• Establishing Framework: It is crucial to create a monitoring plan for all rules. This ensures that the effectiveness of the regulation can be assessed over time and adjustments can be made if necessary.
• Precedent for Good Practice: The International Financial Services Centres Authority (IFSCA) already uses such a model, serving as a successful example for other regulators to emulate.
• Annual Reporting: To enhance accountability and transparency, annual reporting on rule-making activities is suggested. This would provide a consistent overview of regulatory engagement with public feedback.
• Resource Allocation: Substantial resources are urgently needed to strengthen existing regulatory frameworks and enable the implementation of best practices.
• Imperative for Capacity Building: Consequently, capacity building is both urgent and essential for regulators to effectively carry out their enhanced responsibilities and ensure robust, data-driven regulation.

Conclusion

Moreover, piecemeal reforms by individual regulators may not be sufficient to ensure consistent adherence to good regulatory practice. Parliament could contemplate enactment of a law, similar to the Administrative Procedure Act in the United States, with standardised procedures for regulation-making.