Flashpoints between governments and central banks are not new. In the latest episode, tensions between the government and the RBI reached a boiling point when Deputy Governor Viral Acharya in his speech stressed the independence of the central bank.
“...the risks of undermining the central bank's independence are potentially catastrophic, a self-goal of sorts, as it can trigger a crisis of confidence in capital markets that are tapped by governments (and others in the economy) to run their finances,” Acharya voiced in his speech delivered at the A.D. Shroff Memorial Lecture in Mumbai.
He went on to say that those governments who did not respect the independence of central bank would sooner or later “incur the wrath of financial markets, ignite economic fire and come to rue the day they undermined an important regulatory institution.”
Strong words indeed by the deputy governor, got the backing of RBI employees too.
Tensions between the central bank and government have flared in the past too. In June 2017, against the backdrop of a slowing economy, and expectation of interest rate cuts, Governor Urjit Patel stated that the external members of the monetary policy committee had declined a request to meet finance ministry officials just days ahead of the MPC meeting.
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The differences between the north block and the RBI over interest rates were visible under the previous UPA government too, when D. Subbarao was the governor.
Recently, in the United States, President Donald Trump had openly expressed his unhappiness over interest rate hikes by the US Federal Reserve earlier this year. Acharya himself cited in his speech on Friday the conflicts in Argentina, where the government's interference in the central bank's affairs in 2010 led to bond yields surging and hurting the South American country's economy.
The tensions between the government and the RBI have been rising for long and not just over interest rates. A key issue is over the control of state-run banks. Patel had said in a speech in March this year that the central bank had very limited authority over public sector banks (PSB). While all commercial banks in India are regulated by the Reserve Bank of India, additionally all PSBs are regulated by the government of India.
“This legislative reality has in effect led to a deep fissure in the landscape of banking regulatory terrain: a system of dual regulation, by the finance ministry in addition to RBI...this fissure or the fault line is bound to lead to tremors such as the most recent fraud,” Patel had argued. His speech came in the backdrop of the Nirav Modi-perpetrated fraud at the state-run Punjab National Bank this year.
The government though countered that argument, when it informed the Parliament later that the RBI had wide-ranging and comprehensive powers to deal with situations in all banks including PSBs.
Another point of conflict is the central bank's prompt corrective action (PCA) framework. In the wake of rising non-performing assets and deteriorating financial condition of lenders, the RBI has placed 11 out of the 21 state-run banks under the PCA framework. Once the PCA is invoked, various restrictions are placed on the bank's business activities, including curbs on lending and expansion of bank branches, dividends and directors compensation.
The government reportedly wanted the RBI to ease some of these PCA norms, so that these banks could lend more, a move the central bank rejected.
Speaking at the IIT Bombay earlier this month, Acharya made a case for PCA, stating such frameworks adopt the core principals of structured early intervention and taking timely corrective action to restore financial health of banks.
“PCA involves some restrictions on bank's scope and expansion as not doing so would lead to excessive risks on the balance-sheets of these banks. While the intent of PCA is primarily remedial, it can also act as a deterrence and incentivise bank management and shareholders to contain risks so they do not end up in PCA in the first place,” Acharya had said.
Dividends paid by the RBI to the government has also been a pain point for some time now. For the fiscal year ended June 2017, Reserve Bank had almost halved its dividend payout; it had transferred Rs 30,659 crore as a dividend, less than half of the Rs 58,000 crore budgeted by the government.
The RBI move in February to revise its framework for resolution for stressed assets also did not go down well among various circles. As a part of the move, it withdrew all the existing frameworks used by lenders to resolve bad loan problem and as per the new rules lender had to declare defaults even if interest payments had been overdue by just one day.
Now, the latest flashpoint is over the inter-ministerial committee formed by the government, which suggested setting up of an independent regulator for payment systems.
“There is no case for having a regulator for payment systems outside the RBI...Since banks are regulated by the RBI, a holistic regulation by the RBI would be more effective and not result in increased compliance costs if multiple regulators exist for related systems,” the central bank said in a rare dissent note that it made public.
Finance Minister Arun Jaitley fired a fresh salvo against the RBI on Tuesday, stating it had failed to check indiscriminate lending by banks between 2008-2014.
“The central bank looked the other way, there was indiscriminate lending,” he said at an event.
The government officials were reportedly upset with the central bank making public the difference of opinions, neither any official nor Jaitley have reacted publicly to Acharya's speech.
