Responsibility fulfilled

In part 2 of the series, the author argues that some changes made to the RBI board lack merit and examines the role of the central bank in regulating the payment and settlement system

Some changes have been made to the Reserve Bank of India (RBI)  board without adequate discussion. Since the inception of the RBI in 1935, the Act provided for only one government director on its board. It had also been specified that this director would be a nonvoting position. This provision is more important symbolically than in actual practice; in fact, votes are seldom resorted to in the functioning of RBI's board. Even without a formal vote the reality is that the government's representative always has an influential and effective voice in the board. The intention of this provision was to provide a strong signal in favour of independence of the central bank. After the Department of Financial Services was carved out from the Department of Economic Affairs in the Ministry of Finance, provision has been made for a second nonvoting government director on the RBI board. 

This provision amending the RBI Act was quietly inserted in 2012 as a clause in the Factoring Regulation Act (!) with almost no discussion in Parliament. A second amendment was carried out in 2013 as part of the Banking Amendment Act. Prior to this amendment, although members of the RBI board were appointed for periods of four years, the Act provided for them to continue as members of the board until their successors were appointed. Consequently, the membership of the RBI board was always full and continuous. 

This amendment has removed this provision so members of the board now have to demit office after their four-year term is over even if their successors have not yet been appointed. As a result, because of delays in the appointment process, positions on the RBI board have often remained vacant ever since this amendment was adopted. At present, for example, four out of the 14 independent director positions are vacant on the central board; and as many as eight were vacant when the momentous decision on demonetisation was made in November 2016. 

Inflation targeting & MPC

Second, the preamble to the RBI Act was amended in 2016 to give statutory status to the Monetary Policy Committee (MPC), and to mandate inflation targeting as the primary objective of India's monetary policy framework. This move implemented the recommendations of the various committees mentioned earlier and has been widely welcomed as a major monetary policy reform. The composition of the MPC has, however, received little discussion in India. Unlike other major central banks where, in general, all the deputy governors are represented in the MPC, three of the four in the RBI have been excluded. This is particularly unfortunate in a full-service central bank where it is important to derive the benefits of knowledge, information and expertise that the other deputy governors bring from their financial market and banking portfolios and experience. As the NAFC demonstrated all too clearly, monetary policy decisions can depend on assessments of market and banking conditions, and monetary policy can have important implications for other central bank activities. It is critical that central bank activities not take place in “silos”; rather, information and expertise should be brought to bear on decision making across the institution. Thus, the current composition of the MPC effectively weakens the functioning of the RBI as a full-service central bank cum monetary authority.

Payment & settlement system

Third, and most recently, there is a proposal to move the responsibility for governing the payment and settlement system out of the RBI. The Payment and Settlement Systems Act, which currently prescribes the governance of this system, was promulgated as recently as 2007. It formally designated the RBI as the authority for regulation and supervision of payment and settlement systems. It further prescribed that the central board of the RBI should set up a committee for exercising this responsibility conferred on it by this Act. The Act provided for the rationalisation and modernisation of the various payment and settlement systems that existed in the country. 

Illustration by Binay Sinha

By and large, this arrangement has functioned very well and it has facilitated the many digital-technology-related changes that have characterised the transformation of the Indian payment and settlement systems in recent years. It is therefore very surprising that a government appointed official committee has now come out with recommendations for sweeping changes to be made in the legal framework governing payments and settlements in the country. The panel has apparently proposed the creation of an independent Payments Regulatory Board (PRB) and suggested replacing the central bank governor as chairperson with a person appointed by the government in consultation with RBI. 

The governance of payment and settlement systems have long been among the core responsibilities of central banks all over the world. A review of the current institutional arrangements in major countries in this area is available with the Bank for International Settlements (BIS). A careful examination of these BIS documents reveals that the legal responsibility for governing payment and settlement systems in the 20 largest systems rests with their respective central banks, except for the United States (where the Federal Reserve has substantial, but not unique authority) and Canada. It is not clear what the provocation has been for proposing such a far-reaching change in this area, which is at variance with established global practice.

I hope that in this case also wiser counsel will prevail and the recent recommendations for setting up an independent payments regulatory board outside the RBI will not be implemented. What is certainly desirable, however, is that the current oversight committee, which is entirely internal to the RBI, should be more broadbased so that other stake holders are adequately represented in governance of the payment system.

(Tomorrow: Protect RBI’s balance sheet)

The author is senior fellow, Jackson Institute for Global Affairs, Yale University, and distinguished fellow, Brookings India