Reddy hints at RBI giving up supervisory role

Our Banking Bureau

Mumbai, Oct 3: The Reserve Bank of India (RBI) deputy governor Dr YV Reddy on Wednesday hinted at the possibility of giving up its supervisory role over financial intermediaries.

“A beginning was made in recommending divestiture of the RBI supervisory functions in regard to cooperative banks, which would presumably be extended to non-banking financial companies and later to all commercial banks,” Dr Reddy said while delivering the second foundation day lecture at the Indian Institute of Management (Indore).

The RBI has decided to divest its all the ownership functions in commercial banking, development finance and securities trading entities. The RBI also signalled initiation of steps for separation of government debt management function from monetary policy.

“These measures would enable the RBI to primarily focus on its role as monetary authority and enhance the possibility of a move towards greater autonomy,” Dr Reddy noted. The RBI has set up an internal committee to review the existing legal provisions in both the RBI Act and the Banking Regulation Act so as to bring about suitable amendments in them to provide sufficient operational flexibility to it for conducting monetary policy, guiding the development of the financial sector and securing the stability of the financial system as a whole.

The committee made a host of recommendations including the issues providing the RBI the flexibility in respect of monetary policy instruments, supervisory effectiveness, prudential deregulation and governance of financial markets.

It has also recommended the strengthening of institutions in the light of structural changes due to ongoing reforms and encourage transparency and integrity of operations. In a liberalised environment, maintaining financial stability is an important additional objective of policy and the RBI should have the operational skills to manage and limit the damage on account of volatility transmitted via the international economy.

Dr Reddy pointed out the operational constraints at the policy level in this regard.

The continued fiscal dominance, including large temporary mismatches between receipts and expenditures of government, warranting large involuntary financing of credit needs of Government by the RBI. The predominance of publicly owned financial intermediaries and non-financial public enterprises, which has created a blurring of the demarcation between funding of and by government vis-a-vis public sector as a whole. The relatively underdeveloped state of financial markets — partly due to legal and institutional constraints — which blunts the effectiveness of instruments of monetary policy. These issues need to be resolved to enhance genuine autonomy.

At the operational and procedural level, there is a problem of “old habits die hard”. In a deregulated environment, there is considerable scope to reduce micro-management issues in the relations between the Government and the RBI. At the level of degree of transparency, there is a temptation to continue, what has been termed as the “joint-family approach”.

The approach ignores basic tenets of accounting principles in regard to transactions between RBI and Government.