Change the law to strengthen RBI

The Financial Sector Legislative Reforms Commission (FSLRC) started its work in April 2011 and is to complete it in two years.

There is all-round agreement that there is need for revamping the financial sector legislative framework, as a good part of it is archaic. The Commission needs to delineate the legislative framework from financial policy. The legislative reforms should not be driven by a particular policy predilection. Again, while it would be useful to study the financial legislative framework in a number of countries, it would not be desirable to transplant a legislative framework from Ruritania just because it suits a particular policy line. Policy would evolve depending on the situation on hand, though it would need to be within the legislative framework.

A major problem in India is that financial institutions are weak and the government has an overarching role in the micro-management. It is difficult to build strong financial institutions in India and it would be unfortunate if the Commission becomes the hand-maiden for destroying the very few strong financial institutions that are there in the country. The Commission should distance itself from the rough and tumble of inter-regulatory disputes and government-regulator problems. In short, the Commission should strengthen financial institutions.

Over the years, the government has encroached on financial institutions by imposing its will with brute force.

Hostility towards RBI

A quick glance at the Reserve Bank of India (RBI) Act would convince the Commission that the RBI Act was framed in the context of the then Colonial regime which was suspicious of the RBI's loyalty, and this generated considerable hostility towards the RBI. It is unfortunate that the present legislative framework is still tilted totally against the RBI. The present Act sanctifies the RBI being a vassal state of the government.

The RBI is not directly accountable to Parliament and this is the excuse for the government to be overbearing in its dealings with the RBI. The law lays down that the government has the right to dismiss the Governor and Deputy Governors without assigning any reason and there is no redressal machinery to protect the dismissed official. To say the least, this is a legislative atrocity which needs to be rectified.

Façade of autonomy

The government has the right to give directions to the RBI on almost everything, but it rarely uses these formal powers.

While the government calls the shots, there is a facade of autonomy for the RBI; so that the central bank has to face the wrath of the public while, in fact, the government decides the minutiae of policy.

There is a need for greater transparency regarding the role of government vis-a-vis the RBI. This is a major lacuna in the RBI Act. Surely, there should be an accord between the government and the RBI on the policy objectives which should be placed in the public domain and the RBI should, with legislative backing, be provided instrument independence.

The Commission needs to avoid the temptation of taking the stance that “Give me a problem and I will produce an institution”. There is frequent talk of stripping regulation and supervision from the RBI.

The RBI is the ultimate provider of liquidity and a separate regulatory body would not have the resources to provide liquidity. Internationally, the jury is still out and the Commission should avoid any hasty recommendation of separating financial regulation from the RBI.

Debt management

Again, in the area of Public Debt Management, the government is going ahead with the setting up of a Debt Management Office (DMO). The separation of debt management from monetary policy is highly desirable, but there are certain prerequisites to be met.

The RBI should first have total autonomy in the area of monetary policy. Furthermore, the fiscal deficit should be within manageable limits.

In the recent period, the market borrowing is expected to be very heavy and the government would want the larger borrowing placed in the market without any significant increase in interest rates.

In the absence of genuine autonomy, the RBI would be muscled into purchasing large amounts of securities from the market to create room for placement for the fresh borrowing.

Again, with the government directly handling the borrowing programme, it would go back to the reprehensive practice of forcing public sector banks to subscribe to fresh government borrowings.

In the area of banking regulation, there are separate Acts for the State Bank of India, their associates and the nationalised banks. The Commission needs to consider recommending that all banks be incorporated under the Companies Act and regulated by the Banking Regulation Act.

The government as proprietor of public sector banks could consider using its proprietal rights, but should refrain from regulatory action.

There are many issues which would warrant the Commission's attention but they should be dealt with in a non-partisan manner, and it should avoid fancy recommendations that would result in the Commission's report landing in the scrap heap.

(The author is an economist. >blfeedback @thehindu.co.in )

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