Section 7 of the RBI Act, 1934: All you need to know

Nov 1, 2018 10:22 IST
Section 7 of the RBI Act, 1934: All you need to know

The Union Ministry of Finance on October 31, 2018 clarified that “the autonomy for the Central Bank, within the framework of the RBI Act, is an essential and accepted governance requirement”.

The Ministry also stated that both the Government and the Central Bank need to be guided by public interest and the requirements of the Indian economy and for this purpose, extensive consultations on several issues take place between both the bodies from time to time. The final decisions are then communicated to the public.

The clarification came in the wake of widespread rumours about government’s decision to invoke never-before-used powers by invoking Section 7 of the Reserve Bank of India (RBI) Act, 1934, allowing it to issue directions to the RBI Governor on matters of public interest such as liquidity for NBFCs, capital requirement for weak banks and lending to SMEs.

What led to this situation?

Finance Minister Arun Jaitley on October 30, 2018, during a meeting of the Financial Stability and Development Council (FSDC), blamed the RBI for failing to stop a lending spree during 2008-2014 that left banks with USD 150 billion of bad debt.

RBI Governor Urjit Patel and officials from the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA) attended the meeting to discuss the liquidity crunch.

This rift between the Central Government and the RBI grew after the RBI Deputy Governor Viral Acharya said in a speech on October 26, 2018 that undermining a central bank’s independence could be “potentially catastrophic”, an indication that the regulator is pushing back hard against government pressure to relax its policies and reduce its powers.

Acharya also said that, “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...

Section 7 of the Reserve Bank of India (RBI) Act, 1934

  • The Section 7 of the RBI Act empowers the Central Government to consult and give instructions to the Governor of the Reserve Bank of India (RBI) to act on certain issues, that the government considers serious and in public interest.
  • The Central Government may give such directions to the Bank from time to time, after consultation with the Governor of the Bank, consider necessary in the public interest.
  • Once the Section 7 is invoked, the general superintendence and direction of the affairs and business of the Bank is entrusted to a Central Board of Directors which may exercise all powers and do all acts exercised or done by the Bank.
  • It is considered that such a move could be a last resort for the Government to increase liquidity, ease pressure on banks and businesses, and boost economic growth.

Has the Section 7 been invoked earlier?

The Section 7 had never been used in independent India till now. It was neither even used when the country was close to economic crisis in 1991 and nor in the aftermath of the 2008 recession crisis.

Allahabad High Court’s ruling in context of Section 7

The talks of invoking Section 7 began for the first time during the matter related to power generation which was taken up by the Allahabad High Court in which a case was filed by power producers challenging the RBI’s February 12 circular. The High Court at that time ruled that invoking of the section could be considered. However, the government at that point did not invoke the section.

How this Section operates?

It is not yet clear how this Section operates since it has never been used till now.

Dispute between the Government and RBI

In September 2016, when Raghuram Rajan exited the RBI governor’s office and Urjit Patel took over the central bank, it was believed that the government-RBI tussle would end. This belief was confirmed in November 2016 when the RBI under Urjit Patel approved demonetisation.

However, the situation seems to be same as that of September 2016. The Government and RBI have been crossing swords over a few issues for some time now.

NPA crisis

The government believes that easing lending rules for the 11 banks under the Prompt Corrective Action (PCA) framework could help reduce pressure on Micro, Small and Medium Enterprises (MSMEs).

However, the apex bank differs a bit, contradicting that such a move would undo clean-up efforts against Non-performing assets (NPAs). Currently, 11 out of 21 PSU banks are under the scanner. Dena Bank and Allahabad Bank are even facing restrictions on expansion of business.

Nirav Modi-PNB Scam

At the same time, the Nirav Modi case gained the limelight. Businessmen Nirav Modi and Mehul Choksi are accused in a scam involving their deals with several banks including the PNB fraud of nearly Rs 14000 crore.

NBFCs issue

For the past few days, the Non-Banking Finance Companies (NBFCs) have been pressing the government for more liquidity. But RBI was resolute in maintaining its position against it.

 

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