Is RBI responsible for stability?4 min read . Updated: 08 Aug 2010, 09:49 PM IST
Is RBI responsible for stability?
Is RBI responsible for stability?
The Reserve Bank of India (RBI) has lost the battle for autonomy to the ministry of finance with Parliament passing the regulatory dispute resolution Bill with a few cosmetic changes to the ordinance it replaced. But governor D. Subbarao is not ready yet to give up the bank’s role in maintaining financial stability, which the ministry wants to dilute.
Finance minister Pranab Mukherjee, in his Budget speech, spoke about the establishment of the Financial Stability and Development Council, or FSDC, “to strengthen and institutionalize the mechanism for maintaining financial stability". According to the plan, this council will monitor macro-prudential supervision of the economy, address inter-regulatory coordination issues, and focus on financial literacy and financial inclusion.
RBI wants the council to deal with financial literacy and inclusion and stay away from financial stability. Subbarao used the 10th C.D. Deshmukh Memorial Lecture in Hydrabad last week to strongly justify why financial stability should be an explicit mandate of RBI.
The ministry’s discussion paper on the council, circulated among financial sector regulators in the last week of June, has argued the government has played a critical role in managing financial sector crises and, hence, it should have a strong say in such matters. Citing instances of the finance minister leading the crisis management exercise in India, the paper said the key to crisis response is the “unique ability" of a finance minister to secure the acceptance of decisions across all government agencies in finance, and the potential use of public resources.
But Subbarao’s Hydrabad lecture on “Financial crisis—some old questions and maybe some new answers" has debunked the crisis management theory of the finance ministry. Indeed, the sovereign has a role in maintaining financial stability, but “from an effectiveness and accountability perspective and for preventing as well as managing a crisis, it is imperative to enjoin the executive responsibility for financial stability to a single entity", he said, adding “the central bank is best positioned to be that single entity".
The governor was also emphatic in saying RBI has historically played a central role in preserving financial stability and defended its multiple roles—that of being the monetary authority, the regulator and supervisor of banks and non-bank financial companies, and the payment and settlement system. “This unique combination of responsibilities for macroprudential regulation and microprudential supervision together with an implicit mandate for systemic oversight has allowed the Reserve Bank to exploit the synergies across various dimensions," he said. “The micro-level information coming from supervision of individual institutions has been a valuable input for shaping the macro perspective."
Incidentally, the finance ministry’s discussion paper on the stability council attacked this very model. What did it say? “Microprudential supervision is necessary but not sufficient… When individual firms are properly supervised, it does not add up to a robust financial system." The paper has called for a macroprudential approach—one that sees the financial system as a whole, across all markets and all financial firms.
And the governor has claimed that’s precisely what RBI has been doing. “What we did in India is a classic case of deployment of macroprudential tools to preserve financial stability, action made possible by the Reserve Bank’s broad mandate and the host of instruments at its command. It is interesting, although not surprising, therefore that increasingly the reformed regulatory models around the world are moving towards resembling our model." Claiming that this “system has served us well", Subbarao explained how ahead of the global financial crisis, RBI sensed the unusual build-up of credit in certain sectors such as commercial real estate, consumer finance and capital market exposure, and tightened the flow of credit to these sectors by raising the provisioning norms and risk weights. “This is one of the important factors that shielded us from the worst impact of the crisis."
In other words, while the fiscal authorities stepped in to manage the crisis after it surfaced, RBI anticipated it and took steps in advance to avert it. To the critical question, should financial stability be an explicit mandate of the central banks, Subbarao’s answer is: “Pre-crisis…there was no answer; post-crisis, the answer is mostly yes." But the finance ministry does not think so. Which is why it is proposing that the stability council, chaired by the finance minister, should have two committees under it—the financial sector regulatory coordination committee and financial sector stability committee—with all regulators as members of both the panels.
It has been an interesting debate and one hopes that the finance ministry has the courage and conviction to take it forward instead of taking a bulldozer approach, a la the 18 June ordinance aimed at resolving regulatory turf wars.
Square peg in a round hole
A late evening posting on the RBI website on 3 August created a furore in the media. The statement spoke about a revision in the portfolio allocations of deputy governors. While three deputy governors have been holding between seven and 10 portfolios each, K.C. Chakrabarty has been given four, including rajbhasha (Hindi). There are reports saying he has been punished and stripped of his critical portfolios after he voiced his opinion (off-record) on interest rates and inflation to a section of the media, something central bankers are never expected to do as the financial markets follow every single word of theirs.
I shall abstain from commenting on this as I don’t know what exactly happened. At the same time, I am tempted to say that when a seasoned commercial banker is given a deputy governor’s chair and never allocated a portfolio such as banking operations and development or supervision wherein his expertise lies, he is punished from Day One. I also hope he has learnt the rajbhasha well. After all, he has been handling this portfolio ever since he has become a central banker.
To read all of Tamal Bandyopadhyay’s earlier columns, go to www.livemint.com/bankerstrust
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Comment at email@example.com