The RBI concedes a vital principle
Mains Paper 3: Economy
Prelims level: RBI
Mains level: Indian Economy and issues relating to planning, mobilization of
resources, growth, development and employment
The Reserve Bank of India (RBI) issued after the
meeting of its board of directors on November 19.
Every one of the four decisions taken, including three
decisions related to regulation, was ascribed to the board.
The note also mentions that the constitution of a
committee to examine the economic capital framework of the RBI, which was
one of the decisions taken.
It will be jointly determined by the RBI and the
Government of India.
These announcements constitute a significant departure
from what has appeared to be the position of the RBI thus far: policy
decisions, especially those relating to regulation, are the exclusive
province of RBI management.
Any departure from this position amounts to an
infringement of the RBI’s autonomy.
The government and some of the current nominee
directors on the RBI board have contended that all policy decisions must be
deliberated by the board.
The outcomes of the November 19 meeting suggest that
the RBI has conceded this vital principle.
This augurs well for the relationship between the
government and the RBI management hereafter. Indeed, it may well constitute
a paradigm shift in the functioning of the RBI.
A grey area
The precise relationship between the RBI board and the
RBI management is something of a grey area.
Various experts have made the point that the RBI Act
vests all powers in the board and, concurrently, it vests those very powers
in the RBI Governor.
Whether the board can issue directions to the RBI
Governor in the event of a difference of opinion between the two is not
clear; some experts reject the suggestion outright.
Surely, this applies to the RBI board as well?
It can be nobody’s case that the statute has conferred
powers on the RBI board that were never meant to be exercised.
Let us accept that these powers should be exercised
rarely. Let us grant that the RBI board must play a largely advisory role.
Even so, it is legitimate to expect that all policy
matters would be deliberated by the board.
The RBI management may or may not accept the inputs of
But the board must have its say.
This is elementary corporate governance.
In accepting this principle, the November 19 meeting
of the RBI board marks a big step forward.
Raiding the reserves?
The government’s position is that the RBI’s reserves
are in excess of reserves typically held by central banks elsewhere.
Some commentators have described the government’s
position as an attempt to ‘raid the reserves’ of the RBI to fund its fiscal
The suggestion seems to be that the RBI has cash which
the government wants to steal for its own purposes.
This is a crude mis-characterisation of the position.
The RBI’s reserves fall into two categories:
revaluation reserves which have mostly to do with the change in the rupee
value of the RBI’s holdings of gold and foreign currencies and contingent
reserves which represent plough back of a portion of the surplus earned by
the RBI every year.
The remaining portion being transferred to government
Requirement of contingent reserves
Contingent reserves are intended for risks related to
the RBI’s balance sheet. Let us suppose that these should not be touched.
Revaluation reserves are an accounting entry.
The RBI can reduce some of the revaluation reserves on
the liability side and extinguish an equivalent value of government
securities on the asset side.
The latter step would lower the stock of debt owed by
This would provide headroom for the government to
raise debt for meeting its future expenditure (including recapitalisation of
public sector banks).
Flow of bank credit
The other outcomes at the RBI board meeting have to do
with increasing the flow of bank credit and easing the problems of
borrowers, especially small and medium enterprises (SMEs).
Banks are subject to capital adequacy requirements
that is, they have to hold a minimum of capital against every rupee of loans
The RBI’s requirement of capital adequacy is one
percentage point higher than that of the internationally accepted Basel
norms laid down by the Bank for International Settlements. ]
The government would like to align Indian banks’
requirements with the Basel norms as that would reduce the demands for
capital made on it by public sector banks (PSBs).
The RBI did not yield on this point at the recent
It has agreed to defer an increase in the capital
requirement of banks of 0.625% under another head by one year.
This does give the government some breathing space in
respect of additional infusion of capital into PSBs.
PCA for banks
The RBI has also agreed to consider the government’s
suggestion for easing the norms for Prompt Corrective Action (PCA) for
The PCA imposes restrictions of various kinds on
banks, including restrictions on lending for the weakest banks.
The idea is that banks that are very weak should not
create problems for themselves by making more loans.
They should focus on getting their balance sheet right
by reducing costs, selling some of their non-core assets and the like.
However, if many banks face lending restrictions for a
prolonged period, it could create serious problems for the economy.
Large corporates could get into distress because of
their linkages with distressed SMEs. So can the healthier banks that are
exposed to these corporates.
To use the jargon, a PCA regime has significant
negative externalities. A relaxation in PCA norms, by translating into
higher credit flows, could relieve stress in the broader economy.
This also applies to the decision, approved at the
meeting, to allow restructuring of SME assets of up to ₹25 crore.
The strident demand to enhance flows to non-banking
financial companies (NBFCs), which was heard ahead of the meeting, finds no
mention in the press note.
It appears that the difficulties in rolling over NBFC
debt that followed the collapse of Infrastructure Leasing and Financial
Services (IL&FS), a leading NBFC, have abated somewhat.
Evidently, the RBI was able to make a persuasive case
on this point at the meeting.
It is the broader message of the November 19 meeting
that is reassuring. As a public institution whose actions have enormous
The RBI management cannot rule by fiat. Its actions
must flow from a consultative process. It must explain and justify its
It must be seen to be accountable. The RBI board could
be an important mechanism for ensuring that these conditions are met.
Q.1 The term 'Prompt Corrective Action' often seen in news, refers to:
(a) adopting innovative construction technologies for building affordable house
at rapid rate.
(b) improving financial and socio-economic status of old age artisans and
(c) transforming and expanding Indian firms into Multi-National companies.
(d) taking corrective actions on banks in order to restore their financial
Q.1 Critically evaluate the board discussing all policy decisions may well be a