RBI vs Government: 10 Things To Know

The Reserve Bank of India or RBI, the lender of last resort, is on a collision course with the government

The Reserve Bank of India (RBI) and the government appear to be heading on a collision course after one of the top officials of the central bank warned that undermining the RBI's independence could be "potentially catastrophic". Reports that RBI Governor Urjit Patel may resign after a breakdown in relations with the government also fuelled the crisis.

The fuse that lit this tension is said to be Section 7 of the Reserve Bank of India Act or RBI Act, which empowers the government to issue directions to the "lender of last resort". Last year, former RBI Governor D Subbarao said Section 7 has never been used in more than 80 years of the central bank's history, news agency Press Trust of India reported.

People with direct knowledge of the matter said the Finance Ministry wrote three separate letters in the past few weeks to the RBI on issues ranging from prompt corrective action (PCA) framework to liquidity management and sought a consultation, well within the scope of Section 7 of the RBI Act.

Then came the first sign of trouble last week, when RBI Deputy Governor Viral Acharya warned that "the risks of undermining the central bank's independence are potentially catastrophic". "Governments 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," he said.

RBI Deputy Governor Viral Acharya last week rebuked the government for interfering in the top lender's decision-making process

Here are 10 things to know about RBI vs government:

Section 7 of the Reserve Bank of India Act

Section 7(1) of the RBI Act says: "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." Section 7(2) gives the government powers to entrust the running of the RBI to its board of directors.

RBI's reserves

The RBI keeps a large reserve of cash in its money jar, which the government is looking to dip its fingers into, financial analysts and economists say. The government may be of the view that the RBI's large reserve cash, if it is sitting idle, may be put into use. But the RBI is called the "lender of last resort" for a reason -- it may need its reserves to step in if a crisis threatens to bring down the entire financial system.

Dividends to government

The RBI holds Rs 28,724 billion in reserves, which includes foreign currency assets, gold and sovereign debt receipts, according to the latest weekly data released by the RBI. The RBI also gives some of the profit it earns from interest on its bonds to the government. But the government may want more "in public interest"; some analysts have also indicated spending in an election year as the reason behind the rush for funds. The government has reportedly sought more dividends from the RBI in one of the letters.

The RBI holds Rs 28,724 billion in reserves, which includes foreign currency assets, gold and sovereign debt receipts, according to the latest weekly data released by the RBI

Handling of weak public sector banks

Differences between the government and the RBI have cropped up over various issues, including the central bank's handling of weak public sector banks under the PCA framework and ways to resolve bad loans in the power sector. There are also apparent differences between them over tight liquidity and setting up of an independent payments regulator.

Prompt corrective action or PCA framework

The government wants the RBI to exempt power companies under the prompt corrective action or PCA framework, which outlines triggers for declaring a loan account as stressed or non-performing asset (NPA), people familiar with the matter said. The RBI uses the PCA framework -- based on three parameters -- as an early-warning tool to check danger signs in the health of lenders. The PCA framework is applicable only to commercial banks.

Easing loans to small and medium enterprises or SMEs

The government has asked the central bank, reportedly using the privilege provided under Section 7 of the RBI Act, to ease its hold on the reserves for providing liquidity to the market. It has also sought for some constraints on banks for loans to small and medium enterprises or SMEs to be removed, PTI reported.

Finance Minister Arun Jaitley has said communication between the RBI and the government has never been made public

Central bank's independence a Western concept: RSS-affiliated body

Matters took a political turn after the RSS-affiliated Swadeshi Jagran Manch's leader Ashwani Mahajan said the "Reserve Bank of India governor should work in sync with the government or otherwise resign." He said, "This entire talk of central bank's independence is a Western concept. It is not acceptable and feasible here. India is a developing country our main priority is employment and growth of small-scale industries. RBI should stand with government on these issues." The Congress has also accused the Prime Minister Narendra Modi government of undermining the RBI's independence.

Autonomy for central bank essential: Finance Ministry

Without acknowledging that letters have been sent to the RBI, the Finance Ministry in a statement said the "autonomy for the central bank, within the framework of the RBI Act, is an essential and accepted governance requirement. Governments in India have nurtured and respected this".

The RBI's central board, headed by Governor Urjit Patel, is scheduled to meet in Mumbai on November 19

RBI, government communication never disclosed publicly: Arun Jaitley

Finance Minister Arun Jaitley said, "...Communication between the government and the RBI and layers of consultations at what level, how it happened and the nature have never in the history been disclosed publicy."

RBI central board meeting scheduled on November 19

The RBI's central board, headed by Governor Urjit Patel, is scheduled to meet in Mumbai on November 19. This would be the first meeting of the board after RBI's Deputy Governor Viral Acharya highlighted the issues concerning the independence of the central bank. There are 18 members on the central board of directors of the RBI, including those nominated by the government.