With Deputy Governor Acharya’s Criticism Of Government Going ‘Viral’, RBI Needs To Introspect

By all accounts, the relationship between Narendra Modi government and the Reserve Bank of India (RBI) is souring. In a recent speech, Deputy Governor Viral Acharya made pointed mention of at least a few major friction-points between the two to emphasise that the RBI is constrained by lack of autonomy in several areas. One of the issues he flagged was the proposal to create a separate payments regulator where the RBI will have only limited say; the other is its limited powers to discipline and act against erring public sector banks; and the third is the constant government demand for more dividends.

What this verbal powwow suggests is that trust is breaking down between the Finance Ministry and the central bank just when we need it the most. At a time when there is pressure on the rupee and the external account, when large parts of the banking sector need intensive care in the ICU, and when the magnitude of the NBFC cash-flow crisis is still fully understood, neither government nor the central bank can afford to act alone.

So, for Acharya to claim that the RBI is playing a test match (and thus in a better position to secure the economy’s long-term interests) while the government is playing T20 (seeking additional resources in the short-term according to its political timetable) is a bit rich. We have both short-term and long-term issues to address in the financial sector. It is not a simple question of playing T20 or tests. We need both players to be willing to do whatever it takes to stabilise the short term, without sacrificing the long-term focus of monetary and fiscal policies.

Central bank autonomy is necessary no matter what the situation, but the very fact that a Deputy Governor is now trying to bring these tensions out in the open will damage both its independence and the country’s ability to deal with its multiple crises.

Three truths are worth repeating.

One, when the chips are down, it is only government that can be the ultimate guarantor of financial stability. The RBI knows this very well, and must not do anything to undermine the government’s priorities. On the other hand, the Finance Ministry should not do anything to undermine the RBI’s perceived need for independence. So, when the going is tough, the RBI should make its dissenting views privately. Any hint that the two are not on the same page will damage market confidence and India’s ability to deal with the crises.

Two, independence is not an end in itself, nor is it ever absolute. If the RBI thinks it does not have enough freedom to act on any issue, it should also recognise that a government has its own limits. And independence results not from frequently claiming the lack of it but in working together. When government and RBI respect each other’s limitations, both achieve better outcomes.

Three, there is the question of accountability. At the end of the day, governments are accountable to the public, the RBI is not. So, any dissenting view of the RBI on any issue needs to also take this into account.

It is also worth looking closely at Acharya’s claims, which were earlier articulated by Governor Urjit Patel himself when the government pointed fingers at supervisory lapses when the Nirav Modi fraud broke out at Punjab National Bank. Acharya claimed, like Patel did earlier, that the RBI does not have enough supervisory powers over public sector banks. While it is true that the government is owner of these banks, and the Finance Ministry has direct control of their operations, it does not follow that the RBI cannot discipline them. It can fine them, it can put out warnings, and it can silently ask the government to act against erring boards or CEOs if their mala fide actions come to light.

But consider another reality. The RBI has often not acted proactively even against private sector banks, including ICICI Bank, Axis Bank and Yes Bank, whose CEOs are now being shown the door – but after their shortcomings were made public by the media. The simple truth is that the RBI has been a poor supervisor of banks, and more often than not it prefers not to act tough in order to avoid a crisis of confidence in banks, which can lead to bigger problems. In the case of public sector banks, though, there will be no crisis of confidence, for the sovereign stands behind them. So, the argument that RBI needs equal power to discipline public sector banks is debatable. It continues to have oversight over public sector banks, and this is where it failed. Whether it needs more powers to discipline public sector CEOs or not is a secondary issue; it has to focus on better supervision first.

The second point, that there should be no regulator outside the ambit of the RBI, especially in payments, makes more sense. The issue here is fragmentation of oversight if RBI looks at banks and a separate payments regulator looks at regulating both banks and non-banks to the extent of their activities in payments. Here, the argument from the other side is that the RBI tends to be partial towards banks and non-bank players tend to get step-motherly treatment when it comes to even-handed regulation.

This is probably true and the logical way to deal with the situation is a compromise where the payments regulator comes under the RBI but with the non-banks having a larger representation on the regulatory panel. The RBI can be given a veto on decisions of the regulatory board, but asked to explain why it is choosing to over-rule the decisions of the board. The new payments regulator can work just like the Monetary Policy Committee, where the Governor has the right to over-rule its decisions, if need be.

It is on the last point — that the RBI must pay out more dividends to government — that the central bank's arguments are strongest. Regardless of whether the RBI needs more autonomy or not, there is absolutely no question that a central bank must be very well capitalised in order to be credible, especially at a time when it may need to bail out both government borrowings or the rupee using its own balance-sheet strengths. Any bank’s ability to expand its balance-sheet depends on its capital and reserves, and a central bank is no exception to this rule. It is thus odd that some reports in the past claimed that the RBI has excess capital of over Rs 4 lakh crore, a part of which could be returned to the government as dividends, or for capitalisation of public sector banks.

It does not matter if the RBI is marginally overcapitalised. Excess capital is a source of financial stability and credibility, and a central bank must be conservative in estimating its capital and P&L figures.

On dividends, surely it is not beyond the capabilities of the Finance Ministry and the RBI to work out a transparent method of working out real annual surpluses and apportioning a specific share of profits as dividend? It is not rocket science. And dividends can be paid out half-yearly to smoothen cash flows in government.

The RBI did not do well to air it's grievances with the government in public when there are bigger challenges that require both central bank and the Finance Ministry to be fighting on the same side. It should fight its fight behind closed doors, and put on its biggest smile in public. Right now, it should introspect on how it is handling this conflict with the government.