BUSINESS

Inside RBI: small change, big returns

By R A Chandramouliswaran
October 08, 2003 16:21 IST

With Dr Y V Reddy taking over as Governor of the Reserve Bank of India, many commentators have put forward their views on the tasks he faces.

With an innings of about 37 years in the RBI, I would like to share with readers some comments on the central bank's internal working and suggestions for more effective implementation of its policies.

First, there is the question of the RBI's 'autonomy'. This issue, though not new, has become the subject matter of considerable recent debate.

The RBI's annual report during R N Malhotra's tenure emphasised unambiguously the excessive accommodation that the government availed of in the form of issue of ad hoc treasury bills, during most of the financial year, which impinged on the bank's autonomy in carrying out its principal task of monetary policy.

The importance of a central bank's autonomy cannot be wished away. During the 1960s and 1970s, the bank displayed robust independence and greater autonomy while taking a stand on matters and expressing its views to the government.

In the last ten years or so, the bank has become needlessly submissive vis-à-vis the government and the government cannot be blamed for this approach.

Ultimately, it depends on the bank's top functionaries to function in a manner reflecting its autonomy and independence and mere theorising does not really help. The government appoints deputy governors of the bank for a fixed tenure.

A convention has been established that out of three deputy governors, one would be from the bank; one would be a commercial banker to oversee the departments dealing with supervision of commercial banks and the third an economist or a civil servant.

Whatever the past justification for such a convention, this has introduced needless rigidity in the appointment process and is not serving the bank's best interests.

The rationale for appointing a commercial banker as a deputy governor is that with his commercial banking experience, he can be expected to take better decisions on regulatory aspects governing them.

However, about two years ago, the person who was from the biggest commercial bank and appointed as a deputy governor was not given the charge of departments handling banking regulation and supervision!

Some deputy governors who are economists or civil servants displayed an excellent understanding of the conceptual issues and brilliantly handled the tasks relating to supervision and regulation of commercial banks.

They had the benefit of RBI advisory groups including commercial bankers to assist them in formulating policies affecting commercial banks. This arrangement was working very well.

There was an executive director who was a civil servant who had provided superb advice on the regulation and supervision of commercial banks.

But to the misfortune of the bank, this gentleman could not be appointed deputy governor and retained in the bank on the ostensible ground that he did not have the requisite seniority of service.

There were also civil servants and commercial bankers to whose style of functioning the meticulous RBI officers had difficulty adjusting.

The RBI is entrusted with the statutory responsibility of ensuring the health of the banking system and for the purpose is armed with a wide range of regulatory and supervisory powers.

It is important that the dual control over banks, especially the public sector banks, by the government (through its banking division) and the RBI should end.

In all matters relating to banks, the RBI should be the sole authority and the government's views should be conveyed to the RBI and not to commercial banks directly.

In matters relating to regulation and supervision, the bank should be given complete authority without being required to consult the government.

Banks ought also to be given a clear impression by the government that it is the RBI to whom they have to look for in all matters relating to their functioning.

There are two departments in the bank -- banking supervision and banking regulation. This was a messy arrangement created by the bank in the context of a suggestion that the RBI should divest itself of its supervisory function and retain only its regulatory role.

The department of supervision was to act as the secretariat for the Board for Financial Supervision. The board's role, however, overlaps the responsibilities of the department dealing with regulatory functions.

The distribution of functions between the two departments is extremely unsatisfactory and hence the earlier this mess is removed, the better it would be not only for the Bank but also for the commercial banks.

The bank had moved from the transactions-based supervision some time ago to systems-based supervision of banks.

It is now in the process of moving to risk-based supervision. The regulations are wholesome and the fine-tuning of the techniques for supervision is also welcome.

But for the supervision machinery to be effective, the bank should not only train its officers and retain them in the department for a sufficiently long time but should also back up their far-reaching findings in their inspection reports.

If some officials at the junior/middle level, for lack of an overall perspective, attach undue importance to certain unsatisfactory features in the working of a bank, it is the duty of the higher officials (if necessary right up to the level of the deputy governor) to guide them before the report is finalised and released.

After the release of the report, care has to be taken to see that the officers are not demoralised by saying either publicly that the inspection observations need not be taken seriously or by not taking action on the findings.

RBI should not also succumb to the temptation of understating the non-performance of the bank's assets and of diluting action on the irregularities pointed out in the reports.

A former deputy governor's favourite statement used to be that while banking regulation could be light, supervision should be punctilious.

The inspecting officials would also have to be helped not to get overawed by some high- profile banks and their officials.

The effectiveness of the supervision machinery depends much on prompt and effective follow up action on the inspection findings without looking to the personalities or banks involved.

Though the Bank had set up a Human Resource Development Department in 1994, it still seems to be struggling to clearly define the role and responsibilities of this department.

The bank also seems to be in a dilemma over whether promotions should be based on merit or on seniority, given the frequent change in policy.

Recently, in the case of promotion to the post of executive director, the bank has reverted to the policy of promotion based on seniority even while for other posts selectivity continues.

Some decades ago, the RBI was known to be an extremely conservative institution with a well-deserved reputation for fairness and impartiality of its decisions.

It was an obsession with the Bank that similar decisions are handed down in similarly placed cases. This probably led to the over-centralisation.

The issues were argued out in elaborate internal notings and the rationale for the final decision was spelt out to justify the decision and serve as a precedent. Dissent was not discouraged but was carefully considered before the final decision was arrived at.

Dissenting voices were not considered inconvenient since the objective was to take decisions not to suit any individual or institution but in the larger interests.

As with many other institutions in the country, there are disturbing signs that such fearless independence may be slowly eroded with the need for 'consensus' in decision-making elbowing out reasoned dissent.

The writer is a former executive director of the Reserve Bank of India

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R A Chandramouliswaran

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