From Form to Function

Few fields have evolved as dramatically in such a short period as financial regulation. The Global Financial Crisis of 2008 exposed a profound paradox. Many of the institutions at the centre of the collapse were among the world's most listed, most closely scrutinised and most transparent companies. Yet exhaustive disclosure requirements, including those under Sarbanes-Oxley and comparable regimes elsewhere, failed to prevent failures that cascaded across the global financial system.

The response reshaped modern supervision. Capital requirements were strengthened, liquidity standards tightened, and stress testing became a permanent feature of regulation. Recovery and resolution planning moved into the regulatory mainstream, while operational resilience emerged as a supervisory objective in its own right.

Public listing retained its role as an important mechanism for raising capital and protecting investors through disclosure. But the larger transformation was philosophical rather than procedural. Regulators increasingly judged institutions by the risks they created through leverage, liquidity, interconnectedness and governance, rather than by their ownership structure or corporate form.

That evolution raises a natural question for India. Does every element of the Reserve Bank's prudential framework fully reflect a function-first philosophy?

RBI's Mandate
Every central bank ultimately exists to preserve confidence in the financial system. The Reserve Bank of India's mandate extends well beyond monetary policy to safeguarding financial stability across an increasingly complex ecosystem.

That ecosystem bears little resemblance to the one that existed three decades ago. Commercial banks no longer dominate financial intermediation. They now operate alongside NBFCs, mutual funds, insurance companies, pension funds, Alternative Investment Funds, REITs and InvITs.

Digital payments and the rapid growth of systematic investment plans have also altered the flow of household savings, with more money moving directly into capital markets instead of bank deposits. Banks, in turn, increasingly bridge widening credit-deposit gaps through wholesale funding markets. The RBI's task has therefore evolved from supervising individual institutions to safeguarding an interconnected financial network.

Its regulatory architecture has kept pace. Master Directions now integrate governance, capital adequacy, liquidity, related-party transactions and risk management into a unified supervisory framework.

Scaling Risk
A prime example of the modern dynamic unified architecture is the simplified Scale Based Regulations. Introduced in 2021, it replaced a more subjective approach with a transparent asset threshold of ₹1 trillion to identify Upper Layer NBFCs with potential systemic significance. 

Yet thresholds are products of their time. They are calibrated to the size and complexity of the economy at a particular moment and inevitably require periodic reassessment.

That is especially true in an economy growing as rapidly as India's. Infrastructure projects once measured in millions of dollars are now routinely valued in billions. Emerging sectors such as semiconductors, artificial intelligence, advanced defence and clean energy require investments on an unprecedented scale.

In 2026, Samsung Electronics and SK Hynix together announced semiconductor investments worth about $518 billion, equivalent to more than a quarter of South Korea's GDP. India's own economy, now exceeding $4 trillion, is expanding in both scale and financial complexity.

A threshold calibrated in 2021 could not reasonably have anticipated the magnitude of these changes. Recognising this, the RBI itself has provided for periodic reviews of the threshold, acknowledging that systemic significance is not static but evolves alongside the financial system. 

Equally significant is the framework's deliberate design. Its top supervisory layer has intentionally been left vacant, to be activated only if an institution's risk profile warrants extraordinary oversight. Few regulatory frameworks build such flexibility into their architecture.

Regulatory Alignment
A statutory mandate defines the ultimate objective. Prudential regulation consists of the specific measures chosen to achieve it. The ultimate test of any regulatory framework is whether its chosen measures remain structurally aligned with its core objective.

Across most of its framework, the RBI has embraced a function-based approach that focuses on economic risk rather than organisational structure. One notable exception, however, lies within the Upper Layer framework. Once an NBFC crosses the ₹1 trillion asset threshold, public listing becomes mandatory.

Unlike other prudential measures, this requirement is linked to size rather than a specific assessment of leverage, liquidity, governance or interconnectedness — the very factors that modern prudential regulation increasingly treats as the true sources of systemic risk.

Questioning whether mandatory listing remains the most appropriate supervisory tool does not challenge the objective of financial stability. It asks whether a structural requirement continues to fit a regulatory philosophy that has otherwise become increasingly risk-sensitive and function-centric.

The framework itself already acknowledges that identical objectives do not always require identical regulatory treatment. Government-owned Upper Layer NBFCs are exempt from the mandatory listing requirement, recognising that institutional characteristics can justify differentiated approaches.

That naturally leads to a broader policy question. If modern prudential regulation has progressively shifted its focus from corporate form to economic function, should every element of the framework evolve in the same direction? As India's financial system becomes larger, more interconnected and more sophisticated, ensuring that regulatory tools remain aligned with regulatory purpose may matter as much as the purpose itself.

This was Part 1 of Capital without Horizon, which explores whether modern prudential regulation should distinguish between financial risk, corporate structure and long-term enterprise creation.

Part 2 examines how unlisted holding companies finance India's long-gestation industries and why patient capital remains essential for economic transformation.  This will be published next week.

Part 3 assesses whether the RBI's listing framework aligns with its own function-based regulatory philosophy and India's industrial financing needs. This will be published in the week of July 24.