New Delhi: The Indian government should amend the legal framework to give the Reserve Bank of India (RBI) full regulatory and supervisory powers over state-run banks, the International Monetary Fund (IMF) said on Wednesday.

The suggestion comes at a time RBI has sought more powers over these banks, arguing that present laws constrain it from effectively regulating them. RBI has argued that a system of dual regulation—by the government and RBI—exists in the case of state-run banks and it does not have powers to sack the management or board of these banks.

In its annual assessment of the Indian economy, IMF said, “Staff encourages the authorities to follow up on the FSAP (financial sector assessment programme) recommendations, including to amend the legal framework to provide the RBI full regulatory and supervisory powers over PSBs to make banking regulation and supervision ownership-neutral." “The recent large fraud at Punjab National Bank—the second-largest PSB—underscores the importance of steps needed to improve PSB governance and internal controls," IMF said.

RBI governor Urjit Patel had in March flagged that the central bank’s powers are not ownership-neutral. RBI cannot remove directors and management at state-run banks, cannot supersede bank boards, and does not have the power to force a merger or trigger liquidation of state-run banks, he had said.

IMF also sought faster privatization of state-run banks. It sought a comprehensive plan to “improve the governance, internal controls, and operations of public sector banks, including by considering more rapid withdrawal of public ownership".

The Indian government, however, stressed the key role played by state-run banks and argued for a gradual pace of reducing the government’s presence in the financial sector, IMF said.

IMF also stressed the need for improving bank governance, reducing the role of the public sector in the financial system, and enhancing bank lending capacity and practices, thereby reducing the fiscal contingency risks arising from state-run banks in the future. It recommended more far-reaching governance reforms, including removing RBI representatives from banks’ boards and better defining the terms of reference for board members, including the ministry of finance representative, to strengthen the quality and independence of boards.