Financial surveillance: A must

The ever expanding financial markets gave birth to financial institutions, companies which were thought to be the elitist of the elite; companies like Citibank, Bearstearns, Lehman Brothers, Washington Mutual, Satyam, etc. which were held in high esteem both by the regulators and the common man. And then came the bust, the ever increasing underlying risk in the manner in which the operations were conducted by these companies and the financial markets world wide resulted in one of biggest economic crisis the world had ever seen.

It seemed as if the accounting and regulatory framework was governed by market dynamics rather than toeing the line of prudence and conservatism, which probably resulted in the inability of the regulatory framework to gauge the risk, predict the coming financial crisis and take necessary counter measures.

The common man who would otherwise ensure that he steered clear of these risks, contributed towards the recovery in the form of tax payments, which were used by governments as bailout packages for the resurrection. The policy makers were asked questions related to efficacy of the prudential norms and were compelled to evaluate the current status of the regulations and make necessary amends in them with effective time frames for implementation of the same and to ensure effective monitoring post implementation.

The starting point for the new regime is probably by establishing a more systemic approach towards measuring and monitoring overall economic risk. This would entail shifting the focus of the current prudential regime focusing on minimizing risk of failure at an individual level to ensure financial soundness of the financial system to a broader horizon which would place overall economic risk as its primary policy determinant. Along with the focus on a more systemic approach, there should also be an increase in vigil of compliance with prudential regulations at an individual level.

The second major change could be in form of an expansion of financial surveillance by including components of financial system which were earlier deemed to be unimportant based on asset size or other such criteria to increase the regulators reach to effectively manage component risk and also expanding the scope of financial surveillance to products like OTC derivatives which were earlier out its purview.

Apart from strengthening of capital adequacy norms, other measures of containing the impact of market fluctuations in the financials is shifting focus of the provisioning norms, which at current are based on a short-time horizon and backward looking to a more forward looking regime which would take into account potential future market risks.

(The writer is a Delhi based chartered accountant)