Is splitting RBI an option?

RBI as the monetary policy authority deserves autonomy. The problem arises when it also functions as the regulator for banks, writes A K Bhattacharya.

This may look like a finance ministry question, but no one in North Block is raising it right now. The possibility of the ministry raising such a question, though, is no longer remote. Not because some smart officer in North Block may revive this old debate over splitting the apex bank, but because of the manner in which the government is framing the issues with regard to new structures it has proposed to resolve inter-regulatory disputes.

Concerns over splitting the Reserve Bank of India or undermining its autonomy are not new. They have been bothering the government and the apex bank for several decades.

All such past debates, however, have ended with the following view: The central bank has over the years evolved into a fine institution and is indeed among the few institutions in India which have maintained a certain degree of excellence and remained free from corruption. So, why tinker with the structure of such an organisation or do anything to undermine its autonomy?

Yet, the 2010 Budget, presented early this year, had slipped in a proposal for setting up the Financial Stability and Development Council that immediately prompted experts, analysts and bankers to debunk the idea.  Significantly, there was muted reaction from Mint Road, where the RBI headquarters are situated, but the discomfort was difficult to hide.

The finance minister, however, had given a detailed rationale for his idea. In his speech, he argued that the global financial crisis of 2008-09 had "fundamentally changed the structure of banking and financial markets the world over". To be sure, there was even an assurance on protecting the autonomy of the financial sector regulators.

"Without prejudice to the autonomy of regulators, this Council would monitor macro prudential supervision of the economy, including the functioning of large financial conglomerates, and address inter-regulatory coordination issues," the finance minister said.

Alarm bells started ringing once the finance minister talked about the proposed Council taking up inter-regulatory coordination issues. But even before the Council could be formed, an unseemly battle broke out between the Securities and Exchange Board of India and the Insurance Regulatory and Development Authority over the question of who should regulate unit-linked insurance plans.

The dispute went to the High-Level Coordination Committee on financial and capital markets, but there was no resolution.

Instead, the two regulators were engaged in a public spat, creating uncertainty among investors and the markets. The finance ministry asked the two regulators to get the dispute settled through a court of law. When even that did not work, the ministry came out with an ordinance in June, creating a joint committee of regulators to resolve inter-regulatory disputes. And the committee was to be headed by the finance minister.

The central bank was upset and made its discomfort with the new committee formally known to the finance ministry. Even Sebi was upset, but Irda was not opposed to the idea of an inter-regulatory dispute settlement body.

In other words, opinion on the joint committee was divided even among the financial sector regulators. However, RBI took the lead by writing a letter to the ministry, suggesting that either the ordinance on setting up the joint committee be allowed to lapse or it be kept out of the purview of the committee.

Why RBI's reaction to the formation of the Financial Stability and Development Council was muted and why it chose to question the formation of the joint committee a few weeks later is a different story.

But by suggesting that the ordinance be allowed to lapse or it be kept out of the committee's purview, the central bank has only fuelled the earlier debate on the wisdom of keeping both the monetary policy authority and the banking regulatory functions vested in the same body.

Nobody questions the independence or autonomy of the country's monetary policy authority. Once the government lays down the overall policy parameters, the monetary policy authority should be free to devise ways to achieve those goals the way it deems fit. RBI as the monetary policy authority deserves that autonomy. The problem arises when it also functions as the regulator for banks.

Can the status of the banking regulator be any different from other financial sector regulators like those in charge of the capital market, insurance companies or pension funds?

But because the RBI governor discharges both the responsibilities, equating all financial sector regulators becomes an almost impossible task as it rankles purists and policy experts over the question of autonomy for the monetary policy authority.

So, what are the options? Well, the finance ministry may soon start thinking of splitting RBI to separate its monetary policy functions from those of regulating banks.

Ironically, RBI's desire to stay out of the purview of the joint committee has only reinforced the idea of separating its monetary authority responsibility from its functions of regulating banks.

Even the government formula of making the RBI governor the vice-chairman of the committee and letting the regulators have the final say on the agenda of its meetings may be used as the thin end of the wedge to build the ground for a separate monetary policy authority.