How are central bank governors appointed?

A few days after announcing his decision to leave Reserve Bank of India (RBI) at the end of this tenure, governor Raghuram Rajan argued that three years is too short a term at the helm of a central bank. Rajan leaves at a time when the power of the governor is set to be whittled down and a six-member committee will take over the responsibility of the monetary policy.

How does India measure up to the rest of the world in terms of appointing its central bank governor and the role and structure of the monetary authority itself? Data from a Bank of International Settlements (BIS) survey provides some answers.

Tenure of the governor

Firstly, it is clear that RBI governors have the shortest term among major monetary authorities in the word. Brazil is one exception where the tenure of a central bank governor is not fixed but set by the President, but even there the last two governors served between 5 and 7 years. A fixed term is widely seen as a mechanism to reduce the vulnerability of the central banker to political pressure. On average, the BIS survey showed that worldwide, most central bankers serve a term of 5-6 years.

How are governors appointed?

The unexpected departure of Rajan has not only raised questions about the central bank’s independence, but also how central bankers are appointed. Largely, the world over, central bankers are appointed by the head of the state. To be sure, at least on the face of it, in 53% of the 47 countries surveyed, two institutions were involved in the appointment. However, in 36% of these countries, only one institution was involved.

In India, the process is entirely a political one. Though an Appointments Committee is the formal vehicle designated to shortlist candidates for the job, in reality, the Prime Minister’s Office chooses the governor after consulting the finance ministry and the outgoing governor.

Moreover, there are no stipulations in Indian law regarding the qualification of governors, or even for those who will be nominated by the government for India’s first monetary policy committee. An economics or finance background is not de riguer for the job, as is evinced by the record of those who have been appointed to the top job.

Chart 4 shows that globally, professional experience and personal integrity, which can be widely understood to refer to a person’s public perception or reputation, matter the most when it comes to holding a position with central banks’ various policy boards. Educational qualifications mattered in less than 10% of cases.

Legal status of central banks and how they are held accountable

Given the fact that central bankers overwhelmingly depend on the government’s goodwill to be appointed to the top job, the degree of their independence then becomes questionable. Chart 5 shows that globally, only a third of central banks are autonomous institutions.

Most recently established central banks have been established by the state, and the data show that close to half are state-owned institutions. However, there are notable exceptions. For instance, in the US, the board of governors of the Federal Reserve is owned by the state and the regional Federal Reserve banks are private entities whose shares are held by commercial banks. The South Africa Reserve Bank is majority privately-owned, with its shares listed on the Johannesburg Stock Exchange.

The RBI was a private bank originally, but after nationalisation in 1949, it became a wholly state-owned entity. The autonomy of the RBI is a grey area: though it does not legally enjoy the status of an autonomous institution, it largely functions as one.

Central banks are held accountable through a variety of mechanisms. One way to increase transparency is to ensure that freedom of information laws is applicable to them. Data from BIS surveys in 2005 and 2008 show that 64% of the 44 banks surveyed were covered under such laws. Research by academics N.N. Dincer and Barry Eichengreen shows that in 1998 only 28% of 44 central banks released information on macroeconomic forecasts. However, by 2006, over 80% of these banks were releasing this data. Chart 6 shows that setting explicit targets, particularly for inflation, has increased substantially over the years.

Legislature and central banks

While setting explicit targets is one mechanism to ensure accountability, the main mechanism to exercise checks is through the legislature. Chart 7 shows that over 60% of central banks surveyed were accountable to the legislature. Several countries also have various mechanisms to undertake formal proceedings when targets are missed. The legislature interacts with central banks via a variety of mechanisms, such as frequent meetings and consultations. However, as chart 9 shows, mostly these take the form of routine queries.

All said, however, the relationship between central banks and governments is not without friction. In India, previous governors such D. Subbarao and Y.V. Reddy have had disagreements with the government. Another famous example is from 1988 when Alan Greenspan, the Federal Reserve chairman, publicly rebuked a Treasury official who had written to him requesting an easing of monetary policy.

Chart 10 shows that while such incidents occur throughout the world, they are more common in emerging countries.

In the paper ‘Bankers, Bureaucrats, and Central Bank Politics: The Myth of Neutrality’, academic Christopher Adolph used data to illustrate his argument that even when central banks are legally independent, partisan governments can shape monetary policy by careful selection and retention of central bankers, who can be influenced by their professional and sectoral backgrounds as well as by their career concerns.