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It bats for “quantitatively measurable” regulators
Like all economic entities, the performance of the financial regulators should also be capable of quantitative measurement. That will ensure clarity in objectives, operational autonomy and accountability in the exercise of powers -- all conducive to a mature, stable macro-economy.
THESE ARE TIMES when comprehensive revamping of the legislative framework of the Indian financial sector is being seriously talked about. The recently submitted report of the Financial Sector Legislative Reforms Commission (FSLRC) probably represents an important landmark in the long march towards revamping Indian finance.

But, the FSLRC’s report does not unfortunately represent a culmination of the efforts to restructure the Indian financial system.

What to regulate if there is no development?

It is a well-known fact that ‘regulators’ in the Indian financial sector so far have focused more on the ‘regulation’ aspect of their respective charters. Development of the respective spheres of the financial sector, which they ‘regulate’, has not attracted the level of attention it deserves. If things go the way they have gone on for the past many decades, one wonders what they will ‘regulate’ if there is no ‘development’ at all of the respective segments of the finance industry!

Serious under-performance of RBI

For instance, the preamble to the RBI Act 1934 says that the RBI will keep reserves to secure monetary stability and generally operate the currency and credit system of the country to its (country’s) advantage. Now, how do these lofty ideas propounded in 1934 correspond to the hard fact in 2013 that the level of exclusion from the credit markets in India is staggeringly large –  it is documented that banks meet just 15 per cent of the total credit requirements of the large and diverse MSME sector in our country. (The MSME sector’s annual credit requirements are close to Rs.2000,000 crore. The sector accounts for a 50 per cent share of employment, exports and industrial / services output).

As for attempts to increase the flow of credit to the MSME sector from non-bank sources (primarily through NBFCs), the RBI’s philosophical stance is to pay lip service to the criticality of NBFCs in overall financial intermediation but framing regulations in such a way as to constrain their operations and growth. It is no surprise that the MSME sector even today meets 3/4 of its credit requirements only through un-organised and local moneylenders.

Now, is that operating the credit system to the country’s advantage? It can be seen that the RBI has seriously fallen short of attaining even amorphous and un-quantitative objectives such as “operating the credit system to the country’s advantage.”

As for monetary stability, the less said the better. The RBI’s serious under-performance in preserving the purchasing power of the paper currency is there for all to see. The inflation experience of the past 40 years testifies to it as consumer prices in India have increased at close to a double-digit annual rate.

In this depressing environment of regulatory under-performance, the case for clearly defined, quantitative and measurable economic objectives for a policy-maker and regulator such as the RBI is very strong. And that is what the FSLRC has strongly recommended.

Same story in insurance

Something similar is the state of affairs in the insurance industry also. The Insurance Act of 1938 vintage and the regulatory authority (IRDA) formed in 2000 also does not have any quantitative developmental objective in its founding charter. Indeed, given the high level of insurance exclusion in India, one would have thought that the IRDA charter would specifically mandate levels of insurance penetration and premium growth to be attained over specific time-periods. Incidentally, the ‘D’ in IRDA stands for development of the industry.

Unfortunately, the focus of the regulator on development has taken the backseat  if the ‘developments’ in the life insurance industry of the past decade are any indication. After a phase of rapid growth in the early years, the overall life insurance industry is now stuttering in the face of regulations which have come not only in rapid succession, have been quite at variance with the imperatives and requirements of marketing a risk management product such as insurance but also have been quite divorced from the overall macro-economic environment.

Indeed, for promoting any financial product, two kinds of facilitative tools are required. One is the underlying macro-economic environment in terms of levels of interest rates, yields, inflation expectations of the investing public, earnings prospects of competing instruments such as equities, bonds etc. This is the foundation. On this macro-economic foundation, the regulations governing the distribution infrastructure, network and the specific marketing and business developmental strategies of individual market players are the super-structure.

It is critical to get both these facilitative tools right. They should be appropriate to the needs of the situation.

Macro-economics in insurance and industry-specific regulations

It is distressing to note how all stakeholders in the financial system are now complaining of a serious drain and deceleration in household financial savings, which includes insurance also. They recognise now, after all these years, that the key causative factor behind that serious deceleration is the ‘brazenly’ negative rates of real return on conventional financial savings such as a bank deposit or a traditional insurance product.

Unfortunately, a perspective and long-range understanding of how repressed interest rates in the financial system can adversely impact the development of products such as insurance was not available (to the regulator) in 2000. Real rates of return were negative even then and this was the key driver behind the growth of equity-market linked insurance products, known as ULIPs. Now, unless this foundational macro-economic picture is understood and regulations are tailored appropriately for that situation, we are bound to have a high level of instability in the business performance of individual insurance companies as well as in the performance of the overall industry itself. In that situation, confusion and under-performance will be confounded if the regulations, as it is unsympathetic to the macro-economic reality on the product side, also pose obstacles on the development of a micro-market distribution and marketing infrastructure.  

The reality now in India is of financial repression and consequently unrealistically low interest rates on conventional fixed income instruments such as bonds.

Therefore, marketing a product such as insurance, which is not completely a savings product but encompasses a significant risk component will be all the more difficult. Regulations on products such as equity market linked insurance and that on the distribution infrastructure such as on insurance brokers, the agency network, the incentive structure for agents etc have to be keenly clued into that brutal reality. But, if the speed-breaker, which the insurance industry has faced in the form of regulations is any indication, the ‘regulatory and development authority’ does not seem to be clued into that overall reality.

Another key point which observers have pointed out as hindering the growth of insurance is the prevalence of ‘relatively’ high claim rejections or repudiations – particularly in General Insurance (GI). Some have even indicated that if this trend grows, it could even lead to de-penetration instead of increasing penetration.

High claim repudiations, at least, do not seem to be supported by the published data. The incurred claims ratio of the private sector GI industry, across all segments, in fact, increased from 77 per cent in 2008-09 to 88 per cent in 2011-12.  

Be it as it may, the reported aberrations on the claims front do highlight the weaknesses in the underlying macro-economic environment. At the macro level, high inflation can vitiate the overall business environment, as general insurers have to more sharply balance penetrative pricing strategies with the level of risks they are insuring and the cost of financial obligations they assume. Insurance loss is indemnified at on going price levels. As a result claim payments may increase sharply if the underlying inflation is high and if insurers have not factored this into their loss reserves provisioning.

Overall, one cannot over-emphasise the need for a sound and stable foundational macro-economic environment for promoting products such as insurance.  

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