The government has sought a discussion on governance in the Reserve Bank of India (RBI) and an appropriate economic capital framework during the central bank’s board meeting scheduled Monday, sources told The Indian Express. Both sides, sources said, have covered considerable ground in addressing two issues: ensuring relief and more credit to small and medium firms, and easing restrictions on state-owned banks to boost lending.
Governance in the central bank is part of the meeting’s agenda, sources said. The government is also looking for a consultative process in decision-making to align the overall economic policy framework, given its differences with the central bank over many issues, sources said.
These differences led to the government invoking, for the first time, a provision in the RBI Act-Section 7 to start the formal process of consultation with the RBI Governor on issues such as easing the prompt corrective
action (PCA) framework for PSU banks, boosting liquidity and credit to medium and small enterprises and Non Banking Finance Companies (NBFCs), and transferring additional surplus from the RBI to the government.
Sources said the meeting of the RBI’s Central Board is likely to work out solutions on issues relating to the PCA framework and liquidity for SMEs and NBFCs. The regulator is looking at a possible restructuring of loans to MSMEs, including the size and cutoff for providing relief to such borrowers.
However, they said, the government may push for broader changes in the decision-making structure in the RBI. “The thinking within the government is the RBI has taken a number of crucial measures, which have a bearing on the economy, but with less accountability,” sources said.
Eleven state-owned banks have been placed under the PCA framework. The PCA is triggered when the financials of banks deteriorate in terms of capital and return on assets leading to the regulator imposing restrictions, including on lending and payment of dividend, and boosting the loan book. Sources said that a PCA review was due in December and, with the resolution of some bad loans due to the insolvency law, the lenders would be in a better position to be taken off this framework.
Express Explained | Decoding RBI’s Central Board
”Unlike other financial regulators like the IRDA or Sebi, there is no appellate authority, which can scrutinise the RBI decisions. In other financial regulators, the respective boards take the decisions. In the case of the RBI, the Governor and Deputy Governors take the decision. The RBI board has only an advisory role,” said official sources.
Governance in the central bank is being seen as a “sensitive issue”, given the RBI’s view that it has operational independence.
”To my mind, the issue is about improving the RBI’s corporate governance. The RBI’s board governance has been, in my view, somewhat weak. They are, perhaps, not used to external board members asking questions. Unlike other regulatory bodies, the RBI has been a largely inbred entity,” said K K Srinivasan, former wholetime member on the board of the Insurance Regulatory and Development Authority of India (IRDA).
According to a former director on the RBI board, the Governor used to take major decisions with the board having only an advisory role. “When I was on the board of RBI, it was a peaceful working relationship. The tussle between the RBI and the government never got out of hand or reached this level. The board only advised the Governor on various matters,” he said.
RBI observers say the government has been preparing for action for some time. On August 7, it appointed S Gurumurthy, who is associated with the Swadeshi Jagran Manch, to the RBI Central Board. What further upset RBI officials was the move to cut short the tenure of Nachiket Mor on the RBI Board in September, at a time when more than half of his tenure was yet to be completed.
ALSO READ | Sensex, Nifty surge ahead of RBI board meet
According to sources, Gurumurthy raised the issue of funding for small and medium enterprises at the previous RBI board meeting in October, and that of surplus reserves. The argument is that the RBI is holding or maintaining excess reserves with current reserves at over 26 per cent of its total assets compared to the global average of 14 per cent.
The RBI board has adopted an Economic Capital Framework — capital that is needed to shield or protect the central bank against future shocks or losses.
The view of some directors on the board is that the RBI is holding excess reserves and that the government, which is the owner or sole shareholder, should receive a larger share of the surplus or dividend.
The counter view, according to sources, is that a distinction has to be made between stock and flows in the bank’s balance sheet. “That is because the central bank holds a large stock of foreign securities against its foreign exchange reserves. The gains in these securities, like in US treasury bills, securities of other central banks, AAA-rated entities, gold and in domestic securities, are notional and it is important to make a distinction. Besides, we have to take into account the fact that the RBI is the lender of last resort and has to ensure financial stability,” the sources said.
They said the economic capital framework and the issue of transferring a surplus to the government may take time to be addressed and the board may prefer to have a committee to provide direction on these two issues, and on governance.
The Indian Express reported on November 6 that at the heart of the RBI-government standoff is a proposal by the Finance Ministry seeking to transfer a surplus of Rs 3.6 lakh crore, more than a third of the total Rs 9.59 lakh crore reserves of the central bank, to the government.
Another contentious issue, sources said, is the capital requirement of banks, with the government and its nominees pitching for aligning it with the international Basel requirement of 8 per cent; the RBI has insisted on 9 per cent.
Besides, sources said, the RBI’s February 12 circular scrapping all loan recast norms were unilaterally taken by the central board without consultation with the government.
RBI Deputy Governor Viral Acharya warned last month that “governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution”. These remarks prompted a strong response from the government, including Finance Minister Arun Jaitley and Secretary, Economic Affairs, Subash Garg, who is on the RBI board.
The Finance Ministry said that while the autonomy for the RBI “is an essential”, both the government and the RBI have to be “guided by public interest and the requirements of the Indian economy”.