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Unit 14: Regulatory Environment

industry association. For example, the foreign exchange dealers have their own self-regulation Notes
in addition to several other statues and guidelines that govern their activities. Similarly, the
merchant bankers association is developing self-regulation that will govern their members in
addition to SEBI regulation. In the US and other developed markets, there are associations for
financial analysts which admit the members after they pass examination and evolve code of
conducts when they desire to practice as financial analyst.
The regulations in general aim to ensure the soundness and safety of financial institutions,
maintain the integrity of the transmission mechanism and protection of the consumers of financial
services. The regulations also ensure freedom of operation to improve the efficiency and provide
adequate scope for innovation that benefit the investors and other participants. The success of
the regulation thus not only depends on its ability to ensure investors protection but is also
determined by the level of advancement and sophistication the system has achieved. In other
words, regulation should not block the development of financial service industry.

Tasks
1. State the broad objectives of regulation relating to financial services.

2. Give a few examples of prudential regulations relating to stock broking service.
3. Why do we need regulators when there are comprehensive legislation covering
different financial services?

14.3 Regulations on Banking and Financing Services

Financial intermediaries mobilize savings and allocate (lend) capital to different users. Savings
and capital allocation are two important activities of the economy and they together determine
the growth of the economy. Often, these two are used to change the direction of the economy to
achieve desired results. The Governments all over the world frame the polices relating to
savings and capital allocation but entrust the responsibility of monitoring them to the central
bank. In India, the Reserve Bank of India, as the central bank of the country, is the nerve centre
of the Indian financial system. It regulates all institutions that are connected with savings and
capital allocation. By regulation, it does not mean that RBI determines the savings rate or the
capital allocation ratios to different sectors or firms in the economy. While in a closed economy,
these are determined by the government whereas in a free-market economy to which India is
slowly moving, these are by and large determined by the market forces. The role of RBI is to
frame regulations that help the orderly functioning of the institutions that raise and lend the
capital. Commercial banks and non-banking financial institutions are two major set of institutions
that come under the regulation of RBI.

14.3.1 Banking Institutions

In order to develop a sound banking system in the country, the RBI regulates the commercial
banking institutions in the following ways:
(a) It is the licensing authority to sanction the establishment of new bank or new branch;
(b) It prescribes the minimum capital, reserves and use of profits and reserves, distribution of
dividends, maintenance of minimum cash reserves and other liquid assets;
(c) It has the authority to inspect or conduct investigation on the working of the banks; and

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