• The tension between the government and the Reserve Bank of India appeared to have defused for the time being at the end of an over nine-hour board meeting.
• RBI governor Urjit Patel’s tenure started seemingly cordially, with the governor seen to be backing demonetisation within weeks of his appointment in Sept 2016.
• But ties soon soured over the issue of interest rates when the MPC led by him refused to meet chief economic adviser Arvind Subramanian ahead of a decision on rates.
• Starting with the issue of interest, many points of contentions between the RBI and the government came into the light, due to which a high-level committee was discussing on the probability of invoking section 7 of the RBI Act if the logjam between the two persists.
• Section 7 gives the power to the government to issue direction to RBI.
• The recent meeting was to settle many disputes between RBI and the government.
Points of contention between RBI and the centre
• Dividend payment:
o RBI surprised the government by transferring only Rs30,000 crore surpluses against the budgeted Rs 66,000 crore, prompting the finance ministry to seek a higher payout, which the central bank had turned down.
• Restructuring schemes for MSMEs
o The sector is badly hit due to twin blows of demonetisation and patchy implementation of Goods and Service Tax (GST).
o Moreover, RBI banned all loan restructuring schemes and asked banks to set aside funds for potential losses (called provisioning) even in case of a one-day default.
o The government asked of restructuring schemes for MSMEs.
• Governing issues in RBI
o It started with the government ticking off RBI for its failure to detect the Nirav Modi-triggered fraud at PNB.
o Governor Patel responded by blaming the government for not giving the regulator the same powers as those for supervising private banks.
• Prompt corrective action
o The RBI had placed half the public sector banks under lending restrictions by imposing its ‘prompt corrective action’ on them.
o The PCA forces the government to recapitalise the banks before they can lend again.
o The government has been nudging the RBI to lift these restrictions in the wake of the liquidity crisis.
• Payments regulator
o An inter-ministerial committee for finalisation of amendments to the Payment & Settlement Systems Act, 2007 had suggested the creation of a payments regulator, which would bypass the central bank’s powers over payment and settlement systems.
o In a dissent note, RBI had said that the payment system is bank dominated and its regulation by the central bank is the dominant international model.
• Liquidity for NBFCs
o The IL&FS default had led to a liquidity crisis for finance companies.
o This in turn was threatening to spill over to markets as nearly 40% of debt investment by mutual funds was in these financial companies.
o During a similar crisis in 2008, the RBI had enabled purchase of assets of NBFCs through a special purpose vehicle.
o The government wanted to replicate this facility, which was opposed by RBI.
o The government has been eyeing the “surplus reserves” with RBI, arguing that most other central banks are not sitting on this kind of a cash pile.
o RBI is unwilling to let go of this kitty as it sees this as an important tool to manage exchange rate risks, which it believes should not be used to bridge the Centre’s fiscal deficit.
Highlights of the recent meeting
• The tension between the government and the Reserve Bank of India appeared to have defused for the time being with both parties agreeing to settle for a middle ground at the end of an over nine-hour board meeting.
• RBI’s capital
o The most contentious issue that the central bank and finance ministry locked horn was the issue of RBI’s capital.
o The RBI has agreed for setting up of an expert committee on the economic capital framework (ECF) its mandate is restricted to future earnings and not the existing reserves.
o The membership and terms of reference of the committee will be decided by the finance minister and RBI governor.
• Prompt Corrective Action
o Board for Financial Supervision (BFS) of RBI will review the norms and will take a call if some of the parameters like net non-performing asset (NPA) ratio could be relaxed so that some of the banks come out of the PCA.
• Credit for MSMEs
o Another significant decision was relief to the micro, small and medium enterprises.
o The Board also advised that the RBI should consider a scheme for restructuring of stressed standard assets of MSME borrowers with aggregate credit facilities ofup to ₹250 million [₹25 crore], subject to such conditions as are necessary for ensuring financial stability.
• Capital adequacy ratio
o After many deliberations to reduce it to 8%, it was finally retained at 9%.
o The deadline for implementing the last tranche of 0.625% under the capital conservation Buffer (CCB),has been extended by one year, that is, up to March 31, 2020.
• Other issues
o Two other important issues that is liquidity for non-banking financial companies and governance issues of RBIcould not be discussed.
o Those will be taken up in the next board meeting, scheduled on 14 December.
About Section 7 of the RBI Act 1934
• Section 7 of the RBI Act reads:
• “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.”
• “Subject to any such directions, the 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 powers and do all acts and things which may be exercised or done by the Bank,” it adds.
• Till now this section has never been invoked.
About Board for Financial Supervision (BFS)
• The Board for Financial Supervision (BFS) was constituted in November 1994 to supervise the money market institutions in the country.
• The BFS has been constituted as an autonomous body under the RBI.
• Board is drawn from the members of the Central Board of the Reserve Bank with the Governor as Chairman and one of the Deputy Governors as full time Vice-Chairman.
• The Board exercises the powers of supervision and inspection under the RBI Act, 1934 and the Banking Regulation Act, 1949 in relation to the different sectors of the financial system.
• The BFS was initially given the mandate for supervision of commercial banks, Financial Institutions and NBFCs.
• Later, urban cooperative banks and primary dealers were also brought under the purview of the BFS.
• Since its formation, the BFS meets every month, conducting on-site supervision of banks and off-site monitoring, based on quarterly reporting system.