NPA Crisis

Explained: Section 7 of RBI ActDOMR


Note4students

Mains Paper 2: Governance | Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

From UPSC perspective, the following things are important:

Prelims level: Section 7 of the RBI Act, 1934

Mains level: Govt- RBI autonomy issues


News

Context

  1. Section 7 (1) of The RBI Act, 1934, became a contentious issue after the tension between the central bank and government turned into a public spat over the last few days.
  2. No government has so far invoked this section in the central bank’s 83-year history.

The widening rift

  1. Simmering differences between the Reserve Bank of India (RBI) and the government – over issues of public sector bank regulation, resolution of distressed assets and the central bank’s reserves – have reached a high-point.
  2. Disagreements and differences between the central bank and the Centre are traditional and often seen as inevitable.
  3. But the latest tussle between the RBI and the union government is actually a series of smaller disputes .
  4. They go beyond the classic debate and spill into the more contentious realm of policy-making and regulation.

Reaching a Flash Point

  1. Amid these tensions the govt. has initiated steps towards invoking its powers under Section 7 of the RBI Act of 1934.
  2. It is a provision under which the government can give directions to the RBI to take certain actions “in the public interest”.
  3. This provision has been built into the law governing not just the RBI but also regulatory bodies in other sectors.
  4. Until now, however, the government has never exercised its powers under Section 7 of the RBI Act.

Section 7 of the RBI Act, 1934

  1. Under Section 7, “The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest.
  2. Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank.
  3. Section 7 has two parts — consultation and then issuing a direction to the RBI for taking some action in public interest.

 For first time

  1. It is rumored that he government has started the first step towards invoking those powers under Section 7.
  2. It is to start consultations with the RBI Governor on issues such as easing the PCA framework, providing more credit to small units.
  3. Such moves have reportedly upset the central bank.

War of Words over Autonomy

  1. In a speech at a function, RBI Deputy Governor had warned that government.
  2. He said that the Govts. that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.
  3. While RBI Governors had conflicts with the government earlier too, these had never reached the extent of initiating consultations under Section 7.

Arguments by the government

  1. The autonomy for the central bank, within the framework of the RBI Act, is an essential and accepted governance requirement.
  2. Governments in India have nurtured and respected this.
  3. Both the Government and the Central Bank, in their functioning, have to be guided by public interest and the requirements of the Indian economy.
  4. For the purpose, extensive consultations on several issues take place between the duos, time to time and this is equally true of all other regulators.

Core of the Issue

  1. The government has only initiated consultations with RBI on different issues under Section 7 (1) and not invoked it.
  2. The govt has send written consultations to the RBI citing Section 7, without actually implementing it.
  3. These letters were to do with the Centre’s desire for the:
  • Power sector’s NPAs to be reclassified
  • Issue of RBI’s dividends to the Centre and
  • ’s desire for easing the PCA norms so as to increase lending to the MSME sector

Way Forward

  1. Last year, Former Governor Y V Reddy had noted that the government has powers to give directions.
  2. But, in giving directions also, unlike other statutes, consultation with the Governor is necessary in regard to the RBI before issuing the directions.
  3. Independence to the central bank is granted by the government with a specific purpose.
  4. Experience has also shown that trust and confidence will improve if the spending authority, viz., the government is separate from the money creating authority, that is, central bank or monetary authority.

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