Explained: Recent Spat Between RBI and The Government of India

The Reserve Bank of India, known for its restraint, has now tuned combative, showcasing its resentment against the government.

At least two speeches recently made by the top RBI officials underscore the extent of the friction between the Central Bank and the Central Government.

In a speech delivered on Friday, Reserve Bank of India Deputy Governor Viral Acharya warned about the risk of undermining the central bank’s independence and called it catastrophic. He also forewarned that the rash move could trigger a crisis of confidence in capital markets that are tapped by governments (and others in the economy) to run their finances. Showing his resentment, he said that the Government that does not respect central bank independence will sooner or later incur the wrath of financial markets, ignite an economic fire, and come to rue the day they undermined an important regulatory institution.

What is the provocation for the RBI’s public expression of discomfort with the government?
In the wake of the Nirav Modi’s Rs. 13,000-crore fraud at state-owned Punjab national bank, Finance Minister Arun Jaitley questioned the RBI’S role. On Tuesday, the Finance Minister went further saying the central bank looked the other way when banks gave loans indiscriminately between 2008 and 2014. It is this indiscriminate lending Jaitley has maintained that led to the huge pile-up Non-performing Assets (NPAs).
RBI Governor Urjit Patel had earlier responded strongly asserting that the RBI did not have the same regulatory powers over public sector bank, as it does over private banks. The Reserve Bank of  India cannot replace the management and board of a public sector bank or revoke its license.

According to the RBI governor,
“In the case of private sector banks, the real deterrence to fraud arises from the market and regulatory discipline. A private bank failing to meet banks solvency standards and under RBI’s Prompt and Corrective Action would find it hard to raise capital, whereby, it would need to put the house in or order so that it can raise funds from the market and get back to the growth path.  There are incentives to invest in governance, so as to limit frauds and regulators violations. In contrast, this market discipline mechanism for public sector banks is weaker. The government or the sovereign owns these banks, so there is implicitly a stronger perceived sovereign guarantee for all creditors. Perhaps, since the original idea behind bank nationalization was complete government control over credit allocation, in India, the RBI’s regulatory powers over public sector banks are weaker than those over private sector banks.”

The RBI’s Prompt and Corrective Action (PCA), which is a regulatory intensive care for banks with deep holes in their balance sheets, is another flashpoint. There are twenty Public Sector Banks, out of which eleven are operating under emergency measures. However, the government has asked for relaxation of these norms, saying it is impacting the lending ability and therefore, growth.

Viral Acharya, in his speech, says
“Sweeping bank loan losses under the rug by compromising supervisory and regulatory standards can create a facade of financial stability in the short run, but inevitably cause the fragile deck of cards to fall in a heap at some point in future, likely with a greater taxpayer bill and loss of potential output.”

Another point of contention has been – Who will regulate India’s payment ecosystem?
An inter-ministerial committee set up for the finalization of amendments to the Payment & Settlement Systems Act, 2007 was formed by the Government under the chairmanship of Secretary, Department of Economic Affairs, which will have oversight on payments done through e-payments.

The Reserve Bank of India sent a strong dissent note to the government questioning the need for the separate payment regulator. The Payments Regulatory Board must remain with the Reserve Bank and headed by the RBI governor, it said. It also notified that having the regulation and supervision over Payment and Settlement systems with the central bank will ensure holistic benefits.

Another issue has been the government choice of directors on the RBI board. The government recently appointed charted accountant S. Gurumurthy associated with RSS affiliate swadeshi Jagran Manch on the Reserve Bank of India Board.

There is also the tussle over resources. The government is of the view that the Reserve Bank of India is sitting on excess capital and must transfer some of it to meet the government’s fiscal targets. This debate, though, is not new and has been going on for at least two years.

The RBI has said having adequate resources is a part of the central bank’s independence. The RBI believes the use of such a transfer would erode whatever confidence that exists in the government’s intentions to practice fiscal prudence.

The government on Wednesday said the autonomy of the Reserve Bank of India is “essential”, but acknowledged that it holds consultations with the central bank on several matters of public interest.

The statement came hours after reports said that the Centre had initiated talks with the RBI to consider invoking a provision under the RBI Act which has never been used before, which could empower it to issue directions to the central bank on certain matters. This provision was not used even when the country was close to default in the dark days of 1991, nor in the aftermath of the 2008 global financial crisis.

What is section 7 under the RBI Act?
Section 7 of RBI Act states:

1) The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.

(2) Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank.

(3) Save as otherwise provided in regulations made by the Central Board, the Governor and in his absence the Deputy Governor nominated by him in this behalf, shall also have powers of general superintendence and direction of the affairs and the business of the Bank, and may exercise all powers and do all acts and things which may be exercised or done by the Bank.

To soften the blow, Government has come out with a clarification on the purported spat with the Reserve Bank of India. The government has said that the central bank enjoys autonomy within the RBI Act and that both the government and the RBI engage in consultations guided by public interest and the requirements of the Indian economy.

While disagreements between the RBI and government are not new, many experts feel that the particular episode has blown out of proportion, suggesting that it will have a negative effect on financial market sentiments.



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