• UGI USER
  • Apr 01, 2024
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HERE’S LOOKING AT YOU, RBI

Relevance: GS 3 – Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Why in the News?

  • As RBI celebrates its 90th year, we acknowledge its significant role in central banking.
    • The Reserve Bank of India was founded on April 1, 1935, as per the stipulations of the Reserve Bank of India Act, 1934.
  • RBI’s journey has been eventful, adapting to India’s changing political climate.
  • “There have been three great inventions since the beginning of time: fire, the wheel and central banking,” remarked humorist Will Rogers.
  • From socialism to nationalisation of banks, and from heavy-handed regulation to market-driven economics, RBI aligned with the political zeitgeist.

Post-1991 Reforms

  • Transition from stifling micro-regulation and directed credit.
  • Banks granted more freedom and deregulation of interest rates.
  • Limited freedom allowed in the forex market.
  • Issuance of licences to private banks.
  • Presiding over the digitisation of financial transactions and entry of fintechs.

RBI’s Evolution and Perception

  • Originally privately owned, the Reserve Bank became fully owned by the Government of India after its nationalization in 1949.
    • Initially, it was derogatorily referred to as just a section of the finance ministry.
  • BK Nehru, India’s ambassador to the US in the 1960s, reportedly declined the RBI governor post citing the bank’s lack of independence.
  • In recent times, both sitting and former finance secretaries to GOI compete for the RBI governor position.
  • Reflects RBI’s significant journey and increased stature over the years.

RBI’s Assertiveness

  • RBI governors have stood up to both finance ministry bureaucrats and finance ministers.
  • Former governor Raghuram Rajan stated, “We [RBI] are the gatekeepers, and sometimes have to say no.”
  • The decision to hold back on capital account convertibility during the East Asian crisis prevented the country from its worst impacts.

Challenges to RBI’s Independence

  • Instances where RBI either did not assert itself or failed to do so strongly enough, as seen during the 2016 demonetisation.
  • The RBI does not possess complete freedom.
    • As per the Act, ‘The Central Government may give directions to the Bank as it deems necessary in the public interest, after consulting with the Governor of the Bank.’

Strategies to Maintain Autonomy

  • Some governors have outsmarted even determined finance ministers.
  • Former governor YV Reddy’s tactic was to form a committee when faced with a contentious issue, taking inspiration from Charles Kettering’s idea that “If you want to kill any idea in the world, get a committee working on it.”

Assessment of RBI’s Performance

  • RBI Act and Reviews: The RBI Act has undergone several amendments.
    • Unlike Australia and New Zealand’s comprehensive reviews, India has not conducted a root-and-branch review of the RBI Act.
  • Monetary Policy and Exchange Rate Management:
    • Ending ‘ad hocs’ and adopting a floating exchange rate system initiated under former governor C Rangarajan.
    • Inflation-targeting strategy introduced under Raghuram Rajan.

Challenges in Bank

  • Failure in effective supervision of banks and other financial institutions.
  • RBI faces challenges managing multiple, often conflicting objectives, such as managing government debt and controlling inflation.
  • Delays in raising interest rates after the Covid pandemic; tightening cycle began only in May 2022 despite persistent inflation.
  • Regulations and Supervisory Capacity: RBI is prompt in creating regulations.
    • Regulations lack meaning unless supported by strong supervisory capacity.
    • According to a September 2023 IMF working paper titled ‘Good Supervision: Lessons from the Field’, supervision is a ‘public good’, and ‘Regulation is rarely, if ever, enough. Supervision is essential.’
  • Challenges in Supervisory Competence:
    • Reduced reliance on on-site inspections has affected supervisory competence.
    • Resistance to lateral entry prevents fresh industry expertise from entering the RBI.
    • BharatPe founder Ashneel Grover criticizes RBI’s reliance on its in-house experts as outdated.
    • The in-house talent often lacks industry experience, making RBI vulnerable to cunning entities.
  • Bank and Financial Institution Failures:
    • Bank failures are not exclusive to India, but the large accumulation of NPAs and the collapse of major NBFCs like ILFS and Dewan Housing, and banks like Yes Bank and LVB, reflect poorly on RBI.
    • These problems were recognized well before these institutions collapsed.
  • Bank Lending and Fintechs:
    • The significant increase in bank lending to NBFCs was a potential risk.
    • RBI did not act promptly despite the known gaming of the system by many fintechs.
    • Recent actions against entities like Paytm Payments Bank and IIFL Finance have been delayed.
  • Transparency and Accountability:
    • Unlike the US Fed, which conducted an open review after the Silicon Valley Bank collapse, RBI has been reluctant to publicly admit any faults.
  • There is a need for greater transparency and accountability from RBI.

Future Direction for RBI:

  • A comprehensive review of the RBI Act and the bank’s performance is necessary.
  • RBI should use the next decade to demonstrate its adaptability and continuous learning.

RBI’s Structure and Constitution

  • The Reserve Bank’s affairs are overseen by a central board of directors appointed by the Government of India per the Reserve Bank of India Act.
    • Directors serve a four-year term.
  • Official Directors include the Governor, up to four Deputy Governors, and two government-nominated Official Directors.
  • Non-Official Directors consist of ten individuals nominated by the government and four Directors representing regional local boards.
MAIN FUNCTIONS OF RBI

Monetary Authority:

●   Implements and oversees monetary policy to ensure price stability while promoting growth.

●   An amendment to the RBI Act, 1934, in May 2016 established the statutory foundation for the flexible inflation targeting framework.

●   Monetary Policy Committee (MPC):

○    Established in 2016 to enhance transparency and accountability in monetary policy decisions.

○    Comprises six members: the RBI Governor (ex-officio chairman), three members from RBI, and three members selected by the government.

○    The MPC determines the policy interest rate to achieve the inflation target.

○    The inflation target is set once every five years by the Government of India in consultation with the RBI.

●   The current inflation target stands at 4%, with a tolerance range of -2/+2 until March 31, 2026.

Regulator and Supervisor of the Financial System:

●   Sets the overarching guidelines for banking operations, including issuing licenses, branch expansion, asset liquidity, and bank amalgamation.

●   Objectives:

●   Maintain public confidence in the financial system.

●   Safeguard depositors’ interests.

●   Provide cost-effective banking services, including commercial and co-operative banking.

Manager of Foreign Exchange:

●   Manages India’s Foreign Exchange reserves.

●   Facilitates external trade and payments and ensures the orderly development and maintenance of the foreign exchange market in India.

●   Maintains the external value of the rupee.

Issuer of Currency:

●   Issues, exchanges, and destroys currency and coins unfit for circulation.

●   Ensure the public has an adequate and quality supply of currency notes and coins.

Developmental Role:

●   Undertakes various promotional functions to support national objectives, such as establishing institutional arrangements for rural and agricultural finance.

●   Directs commercial banks to lend to small-scale industrial units based on Priority Sector Lending guidelines issued by the Reserve Bank of India periodically.

Financial Inclusion:

●   The Reserve Bank has adopted a bank-led model for financial inclusion in India.

●   Key policy measures include:

●   No Frills Accounts: Accounts with either no or very low minimum balance requirements and minimal charges to make banking accessible to a broad population.

●   Use of Technology: Utilization of ATMs, handheld devices for account identification through cards and biometric identifiers, deposit-taking machines, and internet and mobile banking to offer banking services more conveniently to all segments of society.

Related Functions:

●   Banker to the Government:

●   Acts as a merchant banker for the central and state governments.

●   Manages the central government’s money, remittances, foreign exchange, and oversees its public debt.

●   Banker to Banks:

●   Maintains banking accounts for all scheduled banks.

●   Acts as a lender of last resort by providing funds to banks when needed.

Source: https://economictimes.indiatimes.com/opinion/et-commentary/rbi-at-90-indias-central-bank-must-do-better-on-supervisory-front-to-not-sully-its-track-record/articleshow/108923695.cms

Mains question

Discuss the challenges faced by the Reserve Bank of India (RBI) in supervisory competence. Suggest reforms to enhance RBI’s effectiveness in the evolving financial landscape. (250 words)