IMF roots for apex bank liberty

Mumbai, Jan. 16: The International Monetary Fund (IMF) today said that financial regulators in India do not have "de jure independence" even as it asked the Indian government to scrap provisions in banking laws that allow it to "interfere" in the working of the Reserve Bank of India (RBI).

A report prepared by the staff of IMF on financial system stability in India said certain statutory provisions empowered the government to interfere in the way the country's central bank worked though there wasn't any evidence to suggest that it had actually done so.

The report said the government should scrap these provisions in the interests of transparency and to send out a powerful signal that the RBI's independence would never be undermined.

"Some legal provisions in the Banking Regulation Act allow the central government to give directions to RBI, require RBI to perform an inspection, overrule RBI's decisions, and supersede the RBI Central Board. Removing these provisions and specifying in law the reasons for removal of the head of the central bank during his/her term would provide greater legal certainty regarding RBI independence," the report said.

The report said that even though the oversight regime for banks, insurance companies and the securities markets was broadly in line with international standards, there were some gaps. "A common issue across the sectors is the lack of de jure independence, which can be rendered more challenging by the intricate relationship with state-owned supervised entities and their business decisions," it added.

The RBI, however, disagreed with the assertions made in the report. The central bank said that financial sector regulators in India operate within statutory frameworks that prudently balance the role of government in policy making with autonomy and independence for regulatory bodies.

"The de facto position too reveals no interference in the functioning of regulators. Steps are underway to accord a statutory basis to the pensions regulator also," the central bank added.

Earlier this month, former World Bank chief economist and Nobel laureate Joseph Stiglitz had also debunked the so-called independence of central banks while delivering the CD Deshmukh memorial lecture in Mumbai.

Stiglitz said: "Before the (economic) crisis, American financial institutions and American regulatory institutions (including the Fed) were often held up as models for others to imitate. The crisis has not only undermined confidence in these institutions, but has also exposed deep institutional flaws. It has shown that one of the central principles advocated by Western central bankers'the desirability of central bank independence'was questionable at best. In the crisis, countries with less independent central banks'China, India, and Brazil'did far, far better than countries with more independent central banks, Europe and the United States."

There have been various instances that lend credence to the RBI's assertion that India's regulators are fairly independent. On several occasions in the past, the RBI has resisted the finance minister's calls for an interest rate cut on the ground that inflation-busting was the main objective of the monetary policy.

The RBI also refused to kickstart the process for issuing new banking licences until parliament passed the Banking Laws (Amendment) Bill conferring a wide range of powers of oversight to the central bank. Finance minister P. Chidambaram had said that work on passing the Bill and the announcement of the new guidelines for the issue of banking licences to corporate entities and industry houses could take place simultaneously. The RBI demurred.

This is the first time that the banking industry is being thrown open to corporate entities since banks were nationalised in 1969. Licences for private banks have been issued twice in the past since the liberalisation in 1991. But these were granted to entities that were already operating in the arena of financial services.

The IMF report has cautioned RBI against issuing new bank licences to corporates or industrial houses. It added that international experience supported the prudent policy position of disallowing industrial houses from promoting and owning banks.

``Consolidated supervision frameworks and capabilities are weak even for banked groups in the majority of jurisdictions assessed under the Financial Sector Assessment Program (FSAP), and frameworks for the oversight of financial conglomerates continue to be a work in progress at the international level'', it said.

The report said that in the case of India, the risks of allowing industrial houses to set up banks might outweigh its benefits.

The report estimated that India's domestic banks would need excess capital of up to $ 50.6 billion under the Basel III norms if the economy grows at a rate of 10 per cent and bank credit of 17 per cent. However, in a mid growth scenario (GDP of 8.5 per cent), the requirement will be far less at $ 19.6 billion.

The report also raised the concern that India has large exposure limits vis-�-vis international norms. The current rules allow single group concentration to reach up to 55 per cent of a bank's capital. It said some banks have already breached this high limit. It recommended that the group concentrations should be reduced so that viability of a bank is not threatened by the failure of a single borrower.

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