View: Supervisory independence is as important as monetary policy independence for RBI

A mole in the Indian Banks’ Association (IBA) headquarters in Mumbai reports a sense of quiet satisfaction instead of the usually sombre mood among bankers who come to IBA’s Cuffe Parade office, seeking its intervention with banking sector regulator, Reserve Bank of India (RBI).

No prizes for guessing why. Over the last few months, RBI has been hauled up by more than one authority — and on more than one occasion.

Hence the schadenfreude (pleasure derived at another’s misfortune) among bankers, many of whom have been at the receiving end of RBI’s ivory tower approach to regulation. After all, it’s not often the regulator gets a taste of its own medicine.


Get Up From the Wrong Side
The most recent instance is of the Supreme Court pulling up RBI for failing to make its inspection reports public. Prior to that, the apex court declared RBI’s Feb 12, 2018, circular ultra vires or beyond RBI’s legal authority. Striking it down in toto, the apex court declared RBI could not apply a blanket rule on non-repayment of loans to all bank borrowers, but could only do so on a case-by case basis.

These are not the only instances where the once-invincible RBI has been put on the mat. Earlier, Kotak Mahindra Bank questioned RBI’s directive to reduce promoter Uday Kotak’s stake; and rather than fall in line like, say, Bandhan Bank, opted to take RBI to court.

The National Company Law Appellate Tribunal (NCLAT) ruled against RBI directing banks to classify their exposure to IL&FS as ‘non-performing’, without NCLAT’s prior permission. More recently, the Supreme Court restrained banks from declaring the dues of Reliance Infrastructure’s subsidiary, Delhi Airport Metro Express, ‘non-performing’ until further orders.

All this is a far cry from the days when RBI’s word was law. Sure, there were instances in the past when its authority was challenged. But these were few and far between. In contrast, RBI’s decisions are now being questioned with uncommon frequency.

It’s as if the same public, that once placed RBI on a pedestal, has discovered its feet of clay. The Supreme Court going so far as to warn RBI of contempt of court and NCLAT’s Justice S J Mukhopadhaya reprimanding RBI, accusing it of making the NPA classification a prestige issue.

How should we respond to these developments? Welcome them, as an overdue democratisation of RBI’s powers? Or, more warily, as warning of a potentially dangerous decline of RBI’s supervisory independence and the majesty that must, necessarily, be part of the aura of any regulator; more so one responsible for ensuring financial stability?

Remember what EU head Jacques Delors said about the German central bank, back in 1992? ‘Not all Germans believe in God, but they all believe in the Bundesbank?’

Even if the RBI does not enjoy quite the same halo in the eyes of Indians, there is the very real danger that such instances, especially of judicial overreach, could seriously impair the central bank’s ability to discharge its responsibility as banking sector regulator and custodian of the country’s financial sector stability. And that is unambiguously bad news in a fledgling democracy where we need an apolitical regulator to guard our financial stability.

Ironically, RBI is not the only banking regulator to find its supervisory independence under attack. In a development uncannily similar to the RBI’s run-in with courts, the European Central Bank (ECB) directive to banks to maintain provisions for deteriorating assets was challenged by the European Parliament. ‘Prudential provisions can only be applied case-by-case, not across the board,’ said the European Parliament.

Judgement Day
Really? How can parliamentarians be better informed than the ECB on a technical matter, such as provisioning for bad debts? Likewise, how can the NCLAT or the apex court be better qualified than RBI to opine on the definition of ‘non-performing’?

The problem really is that while few will disagree on the merits of monetary independence, the case for supervisory independence is still evolving. Time inconsistency (a reference to the political class’ tendency to favour short-term goals, ignoring long-term costs) has often been used to argue in favour of monetary policy independence.

But it is no less relevant for banking supervision. If a regulator issues tough regulatory norms, but is then forced to backtrack due to judicial or legislative overreach, then expectations of a lax regulatory regime will set in. With serious adverse consequences, long-term.

So where does one draw the line? The answer: by carefully separating the wheat from the chaff, i.e., by separating purely technical issues from issues with larger macroeconomic implications. Loan classification, for instance, is a strictly technical issue on which only RBI, as the regulator responsible for the safety of banks, should have the final say. Interference by courts runs the risk of introducing discretion in loan classification and opens up a Pandora’s box. However, in other areas, where, for instance, valuable assets have been created with public money, as with stressed power assets, RBI needs to take a more nuanced stance, even as it puts wilful defaulters on the mat.

Wider consultation could help. Directives framed after consulting all interest groups are less likely to be misunderstood/challenged, either in court or through legislation. Unfortunately, this is precisely where RBI often falls short.