Government Vs. RBI ?

Hello readers, in this article, I’m going to talk about the tussle between the Government and the Reserve Bank of India.

The central government is invoking a never-before use power under the RBI Act, one that allows it to issue directions to the central bank governor on matters of public interest given that the RBI as the central bank is intended to be an autonomous institution. This is unusual departure from the norm.

The government can issue directions to the RBI under section 7 of the RBI Act. In recent weeks the government is reported to have several letters to the RBI governor on several issues ranging from liquidity for non-banking financial companies to capital requirements of the weak banks and lending to Micro, Small and Medium Enterprises (MSMEs).

In this article, we talk about Section 7 of the RBI Act and also what led the government to to invoke it for the first time. We’ll also talk about role and functions of the RBI.

To understand this dispute between the Government and the RBI, we must understand the origin of this dispute.

Now amid the reports of mounting tension with the RBI, the finance ministry has said the government has respected autonomy of the central bank and has been holding extensive consultations within on several issues. It said both the government and the RBI in their functioning have to be guided by public interest and the requirement of the Indian economy. Let’s take a look at some factors that led to the differences between the government and the central bank which culminated in the former invoking Section 7 of the RBI Act.

Section 7 of the RBI Act which deals with management has never been invoked before in the history of independent India.

This provision took center stage earlier this year when Allahabad High Court was hearing a petition from power companies who challenged stringent NPA (Non-performing Asset) norms notified by the RBI in February referred to us the February 12th Circular. The court had asked the central government to hold consultations with the RBI under Section 7 of the RBI Act, 1934 on the way forward for stressed power assets within 15 days.

In an unprecedented move, the government has cited the never-before-used power of issuing the directions with the central bank. The government sent at least 3 letters on different issues ranging from Prompt Corrective Action (PCA) framework to liquidity management and sought consultations under Section 7 of the RBI Act which gives it powers to issue any direction to the central bank governor on the matters of public interest.

Government wrote 3 letters in fast few weeks to the RBI-

FIRST LETTER-

  • First letter came out exemption for power companies under PCA framework.
  • Government views that easing rules for banks under PCA could help reduce pressure on MSMEs (Micro, Small and Medium Enterprises).
  • RBI argued such a move would undo clean-up efforts.

SECOND LETTER-

  • Second letter pertained to use of RBI’s capital reserves for providing liquidity to market.

THIRD LETTER-

  • Third letter for relaxing the constraints on the banks for loans to SMEs (Small and Medium Enterprises).

Further more…

  • Government also wants the RBI to cut interest rates considering it a necessity to give the much-needed impetus to the Indian economy. But RBI has not only refused to bring key interest rates but has also raised them.
  • On October 26th, RBI deputy governor Viral Acharya made disagreement with the government, public in hard-hitting speech and blamed government for interfering with RBI’s working.

Days later on October 30th Finance Minister Arun Jaitley blamed the RBI for bad loan crisis in the country. He said that the central government had failed to check indiscriminate lending during 2008 to 2014 lending to the present NPA crisis i the banking industry.

To understand the section 7 of the RBI Act, 1934, First we have to understand the history of section 7 and the RBI.

HISTORY- RBI-

RBI was setup on the recommendations of the Hilton Young Commission that was made in 1926. RBI formed on 1st April, 1935 during the British Raj. RBI formed as per the RBI Act, 1934. There are 61 sections in the RBI Act. RBI was nationalized in 1949.

IMPORTANT SECTIONS OF THE RBI ACT, 1934-

  • SECTION 3- Establishment and incorporation the RBI.
  • SECTION 4- It lays emphasis on the capital of the bank that was 5 crore rupees.
  • SECTION 8- Composition of central board of the RBI.
  • SECTION 17- It elaborates on the business that can be carried out by the RBI.
  • SECTION 18- Emergency loans to banks.
  • SECTION 21- RBI must conduct banking affairs for central government and manage public debt.
  • SECTION 22- Only RBI has exclusive rights to issue currency notes in India.
  • SECTION 24- Maximum denomination of currency can be 10,000 rupees.
  • SECTION 42- Cash reserves of scheduled banks to be kept with the bank.
  • SECTION 45(U)- Defines Repo, Reverse Repo, Derivative Money Market Instruments and Securities.

HISTORY – Section 7 of the RBI Act-

  • RBI drafted provision combining provisions of Bank of England, 1946 and Commonwealth Bank of Australia, 1945.
  • Provision on central government’s powers to issue directions to the central bank. Central bank had however suggested that the act makes it clear that the government takes responsibility when t acts against the Governor’s advice.
  • Government at that time was not in favour of the  provision and the Clause was re-drafted.
  • Section 7 of the RBI Act amended in 1949 to empower center to issue directions to the RBI in public interest.

SECTION 7-

Subject to directions, 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 the powers and do all acts and things which may be exercised or done by the bank.

The section further states that

Unless 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 the direction of the affairs and the business of the bank, and may exercise all the powers and do all acts and things which may be exercised or done by the bank.

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