Legal Framework for Regulation of Financial Instruments


There have been a lot of changes the financial environment has gone through in the past couple of decades. The financial sector has shown tremendous growth like rapid product innovation, policy, regulatory and trade reforms at the same time there are problems of confidence and trust which need to be addressed.  The legal infrastructure plays a pivotal role in regulation of Financial Instruments. Financial Instruments are potentially “dangerous” and they need to be regulated. Insufficient regulation of the financial instrument might lead to a global crisis. Regulation of such financial instruments should be ensured in order to protect the consumers in the market.  It has also influenced the various banking sectors, government and non-government organizations by increasing the variety of financial products available.

Financial Instruments

The Association of Chartered Certified Accountants (ACCA) has the following definition or a financial instrument:

“A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. The definition is wide and includes cash, deposits in other entities, trade receivables, loans to other entities. Investments in debt instruments, investments in shares and other equity instruments”

There are two types of Financial Instruments, cash and derivative. The former includes assets, interest rates while the latter includes market values directly which are transferable securities like deposits and loans.

Financial Sector Legal Framework

A review of the overall legal framework will throw light on both the empowering and guidance laws. A sound legal framework for the regulation of the financial sector might result in the reduction of systematic risks. India is said to be one of the over legislated countries with numerous acts some of which date back to decade. The scope and coverage of the components of the legal framework are outlined below.

·       Central Banking law

The primary objective of the central bank is to ensure an effective payment system and price stability.  The bank should be given full autonomy and must be protected from intruders.  The law should pave way for the central banking law and financial instruments to function in absolute harmony. The laws should provide limits on lending and ensure transparency and it should not allow the banks to do non- banking functions. The law must provide the central bank with proper instruments and powers to attain its objectives.

·       Banking Law

The law should make provisions regarding the requirement of minimum share capital, the criteria and number of directors, managers, shareholders, rules regarding deposits. It should also deal with the issues and make amendments in the field of confidentiality and bank secrecy, especially in anti-money laundering, financing for terrorism etc.

·       Payment Systems

Efficient payment system is the primary requirement of an effective payment system. The legal system should provide various payment systems such as non cash systems to help those relying on plastic currencies. Issues of confidentiality and supervision should also be portrayed by the legislation.

·       Government Debt Management

Government securities play an important role both in developing and developed economies. There should be both a primary and secondary market for the securities where the rights and obligations of the dealers and procedures for registration and transfer of ownership, maturity of bills should be provided. The physical securities should be looked into and make changes in the book- entry. It is very much important for the law to recognize the electronic evidence as per the requirement of the court of law. The law needs to provide a clear legal basis for the issue of debt and the statutory designation of the authorities that are empowered to manage government debt.

·       Capital Markets

Law must give absolute power to the securities market and capital markets and ensure them with key roles in facilitating investment. Misuse of securities markets has resulted in the need for strict rules governing

(a) the issue of securities to the public;

(b) the registration and trading of securities;

(c) the operation of stock exchanges;

(d) the regulation of dealers, brokers, and other persons involved in the securities industry;

(e) the strict requirements for prospectuses as well as for disclosure; and

(f) the operation of publicly listed companies.

Even though the legal aspects of the securities market are already discussed, it must be more effective.

·       Insurance

Insurance needs to be supported by law and already existing regulations should be made effective. It should list out the powers and obligations of the regulator, formation and registration of companies, transparency and maintaining confidentiality in those areas wherever it is required. The exclusion part makes an insurance contract difficult to understand and of these companies always suffers a mistrust between insurance companies and its customers. 

·       Financial Safety Nets

A deposit insurance scheme for bank deposits or for policyholder and investor protection schemes that are designed for insurance and capital markets should be explicitly and clearly defined in laws and regulations that are known to and understood by the public.

·       Commercial laws

There are also commercial laws which affect the functioning of the financial institutes and markets. The scopes of those components which can be made more effective are as below.

·       Company Law

Small statutes providing for formation and registration of various companies like joint stock Company, partnership, LLP etc. should be in place. Those laws should provide a separate provision regarding the number of directors and number of shareholders, shareholders remuneration and extraordinary meetings, role of the board of directors, penalties and accounting and auditing requirements etc.

·       Corporate Governance

A strong corporate governance helps in determining the power of the financial sector and plays a crucial role in building shareholders confidence. The law should provide detailed provisions on the remuneration to the directors and the role and obligation of shareholders and auditors towards the company etc.

·       Consumer Protection

Consumers are the important reason for the existence of the financial markets. Consumer protection is at its utmost importance where they have the right for their personal information to be protected and ensure fair fees structure for all the transactions. It should disclose all its transactions of the consumer and its retail sale terms and conditions.

The Insolvency System

Effective insolvency systems play a major role in making the financial position sustain. A robust Insolvency code can help to promote commercial confidence by ensuring market holders manage the risk of default and non- performance. Although commercial transactions have become more complex as more sophisticated techniques are developed, the basic rights governing them have not changed. There should be a proper legal framework for both the creditor and debtor.

The legal framework for creditor rights includes mechanisms that provide efficient, transparent, and reliable methods for recovering debt, including seizure and sale of immovable and movable assets, as well as sale or collection of intangible assets such as debt owed to the debtor by third parties. There should be a sound regulatory framework for those who are competent enough to exercise the powers. The bodies are finally responsible for i.e. the administrative board should provide for setting standards and reflecting the requirements that are needed to preserve the integrity of the code.

The Judicial System

Economic development and Social growth cannot be developed in a country where the judicial system does not function properly. An effective Judiciary should enforce laws on everybody without any impartiality and efficiently. Courts should resolve disputes justly. Hearings should be open to the public. There should be limited adjournments of matters which are of utmost importance. The court must be effective and sufficiently accessible. 

Although the process of Judicial Review is helpful, proper limits for enforcing it must be provided. The banking law has to draw a line regarding the role of the courts in Judicial Review by disallowing a stay of regulatory decisions.

Alternative Dispute Resolution is not only required to solve the disputes between a bank and non-bank, a bank and its customer but also between a bank and its regulator. They reduce the litigation cost, provide results faster. There will not be any dispute between the parties, since it is the parties decision, they can talk it out and solve their problems by quoting what they have lost amicably. They ensure effective and a good relationship between the bank and regulator and instill faith in the customer on banking law and on the judiciary.


Financial Sector is a very important sector in the economy and is directly proportional to prosperity and growth. There is a need that is felt constantly to regulate and put in place the financial sector laws. The financial system in India including banking, insurance, capital, taxation, etc. has many regulators, each having a separate mandate. Strong financial system makes a strong judicial system which ensures effective legislation.

Even though the current systems are framed in a proper manner, they need to amend frequently in this dynamic world. The amendment should be made in such a way that it should always uphold justice and should accelerate the growth of the financial sector. Revision of banking sector laws should also be motivated by the recognition that it is done for the betterment of the society.


  3. Harvard Business Review

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