Thursday, July 23, 2015

Indian Financial Code v1.1 is out

When the Financial Sector Legislative Reforms Commission (FSLRC) produced the draft Indian Financial Code (IFC) in March 2013, the Ministry of Finance put it out for public review and comments. This version is informally termed IFC v1.0.

Hundreds of comments were received on this first draft. Justice Srikrishna and his team worked on these comments and have come out with a revised draft Indian Financial Code. This is informally called IFC v1.1.

Today, the Ministry of Finance has put this revised draft out for public review and comments.

IFC v1.0 was the result of a thorough and careful process. Even though enormous time and effort was put into it, with the benefit of hindsight, it had numerous blemishes. With the benefit of hindsight, I feel that within IFC v1.0 there were many projects running in parallel, and their inconsistencies of approach were visible in the final product.

IFC v1.1 is a polished product. With the benefit of 853 days of elapsed time, many blemishes have been found. The code is much more orthogonalised: general concepts are consistently applied. It now reads as simple and precise English. I can't think of many laws in India which match the quality of thinking and drafting of IFC v1.1.

Where does this fit into the Indian financial reforms?

India's financial reforms are working on three tracks:

  1. The first element is the legislative process that should, at some point in the future, lead to Parliament enacting the Indian Financial Code. The February 2015 Budget Speech by Arun Jaitley said he will table this in Parliament `sooner rather than later'. The release of IFC v1.1 today is an important milestone in this legislative track.
  2. The second element is building institutional capacity to enforce the new law. In India, building high performance institutions is difficult. As with SEBI or PFRDA or NSDL, it makes sense to build the institutional capacity ahead of time so that when Parliament passes the law, it can immediately be enforced. When the law is enacted without adequate planning for the institutional capacity, this can lead to difficulties as was seen with the Companies Act, 2013.
  3. The third element is to treat FSLRC as the strategy and chip away at incremental changes within the existing legal framework to move towards this goal. This also builds institutional capacity, and reduces the complexities after the law is passed. It front-loads the gains: why not reap the fruits of improved financial sector policy sooner rather than later? Elements of this include: (1) The FSLRC Handbook, (2) the SEBI-FMC merger (backdrop and then Budget 2015), (3) shifting regulation-making power on non-debt capital controls from RBI to MOF (Budget 2015), (4) inflation targeting as the objective for RBI, (5) Finance SEZs, (6) Appeals against all financial agencies other than RBI at a tribunal named SAT.

State capacity is about well drafted laws and sound institutions that enforce these well drafted laws. The Indian malaise with chronically malfunctioning institutions is as much about badly drafted laws as about badly designed organisations. A quantum leap in the law -- the IFC -- will not solve the problem by itself. A similar quantum leap in the working of financial agencies is also required. In order to do this in a systematic way, MOF has invented a new framework involving `task forces' which lay the foundations for a financial agency before the management team is recruited.

At present, five task forces are in motion -- to build the Financial Sector Appellate Tribunal (FSAT) that will hear appeals against all financial agencies, the Public Debt Management Agency (PDMA), the Resolution Corporation (RC), the Financial Data Management Centre (FDMC) and the Financial Redress Agency (FRA).

Each of these five projects would take over three years from start to finish. One one hand, this is frustratingly slow. We need the FRA or the  FSAT or the PDMA or the FDMC or the RC yesterday. But it's not possible to do these things in reduced time. The time horizons for these projects are consistent with the time horizons for IFC to go through the parliamentary process.


  1. Prof. Shah,

    Could you please inform us who has written the IFC 1.1? Justice Srikrishna says he was not part of this new code. So who were the people who made this new code? Some even say IFC has nothing to do with FSLRC. Could you please write a post/article clarifying the issues? Also, an article on the IFC is taking away powers from RBI Governor will be really appreciated. Thanks

  2. Dear Amol,

    On the last question: see RBI independence and Designing the MPC.

    On the precise status of IFC 1.1 see the MOF web page which unveiled 1.1 for public comment. What is going on is standard procedures for every legislation.

  3. Hi Sir,

    Thanks for this. I just wanted to know the authors of IFC 1,1. The document does not mention the people behind the report. As Justice Srikrishna says he is not part of the report. So wondering who all are part of the report.

    I also have another question. I just wished to know that why such a free market thinker like you does not support free banking? I mean whatever we do to RBI and bring it under some law one cannot rule out the sheer hubris and arrogance of a central banker. They all talk about free markets but love to finetune the economy given a chance. We have ample examples of this in the past and the current state of central banking exposes all the nice ideas we had about central banking. It is just such poor policy everywhere despite all the independence and rule based systems. And then the govt can very easily undo the very laws which made central banks so called independent.

    Leave govt. Even central banks can easily undo all the games like RBI is so easily doing. It is targeting exchange rates under the so called modern inflation targeting regime so easily. Given all the smoke and hype around RBI, no one even questions all this.

    Even more philosophically, do you think any central bank can be called independent? It is an oxymoron. Historically, central banks have just served the govt and will continue to do in future. Most central bankers have been part of govt machinery for such a long time and are so integral part of the entire system.

    My simple point is why we don't argue for a free banking system where at best central bank is a regulator of the banking system. Things like and interest rate setting can be done by banks and I surely believe they are far more capable than a central banker. Overall, we can keep copying all these ideas which are shown as best practices. But we know seeing the western central banks that much of this was plain hype.


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