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January 24, 2017

Analysing RBI's Independence

Ajay Shah, in this Business Standard article, analyses the principal-agent relationship of the Ministry of Finance and its financial agent, the Reserve Bank of India (RBI). He proposes that the RBI's indepence as a financial agent would be best achieved by following a "middle ground" in terms of delegation of powers and oversight. Excerpts below: 


"Financial agencies like RBI or the Securities and Exchange Board of India (Sebi) have a legislative function — they write law. This is an unusual arrangement, as the power of making a law normally resides only in Parliament. In recognition of how special this situation is, the legislative function must be controlled by the board. There must be a formal regulation-making process, which is initiated by the board, and involves an institutionalised application of mind. The final decision on each regulation must be taken by the board. Delegation of law-making power to mere officials of a financial agency, as is done at present, is an inappropriate delegation of power. The Ministry of Finance would have a role in this process, by virtue of its membership on the RBI board..."


"...the phrase “RBI independence” is a confused concept, and one that is best avoided. Like other financial agencies, RBI is the agent, and the only reasonable arrangement is where the principal makes appointments, has a seat on the board, and is part of the board process which controls regulation-making, budget-making, organisation design, and holding the management accountable. Nobody can argue that the Ministry of Finance should not be in these things..."


"In order to obtain high performance organisations in government, we require exquisite design of this machinery. These elaborate checks and balances are the secret sauce through which we can obtain institutions which deliver sound performance across staffing changes. The present RBI Act is faulty in having none of this exquisite machinery. It is not surprising that it has failed when put to the test..."


Read the full article here

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