A few years ago, the Reserve Bank of India and State Bank of India were locked in a verbal duel. While India's largest bank was demanding a concession for the industry by way of a reduced cash-reserve ratio (which mandates banks to keep a part of their deposits with the central bank) the regulator was not in a mood to oblige. "If the SBI (chairman) is not able to do business as per our regulatory environment, he has to find some other place," the then RBI deputy governor had said. The two institutions had also fought over the teaser home loan scheme - a mix of fixed and floating interest rate. The RBI had, in fact, clamped down on such loans by increasing the provisioning requirements.
RBI obviously had financial stability concerns while dealing with such issues given that SBI was a systemically large institution. SBI, on the other hand, felt that the banking regulator was using its discretion ruthlessly. Now, the issue of discretionary measures will be settled once and for all.
Since 2008, the RBI had been trying to institutionalise a lot of its decision-making to eliminate discretion. And finally in September 2015, the RBI named SBI and ICICI Bank as the two large domestic systemically important banks (SIBs) and had directed them to set aside more capital than other commercial banks.
The move to target inflation under Raghuram Rajan's tenure was also an effort in this direction. The six-member monetary policy committee set up by Rajan to take a call on interest rates was actually a step towards curbing the RBI governor's veto in the monetary policy setting process. The idea, in fact, was mooted way back in 2008, when D. Subbarao replaced Y.V. Reddy as the governor. In fact, both Subbarao and Rajan's tenures witnessed differences between the RBI and the Centre over interest rate issues. Come October, the policy review will have only a casting vote of the RBI governor in case of a tie among the members of the expert panel.
The RBI has also introduced a clear road map for issuing new banking licences on tap, contrary to the arbitrary decisions by previous regimes. The new regulations take away the discretionary power of the governor to issue licences. However, SBI chief Aundhati Bhattacharya says the RBI governor still has a very large role to play. "The governor will sort of lay out the road map on what needs to be done on various policy issues," she says.
Bhattacharya may be right. For example, foreign exchange management is yet another big mandate where the governor uses his discretion. The RBI is often blamed for interventions in the forex market to protect excess volatility in the value of the rupee - either way. Subbarao, in fact, addressed the issue of discretion in his recent book: "...I think more rules and less discretion will, in the long run, yield sustainable benefits by better managing expectations and minimising opportunities for self-fulfilling and speculative behavior." Similarly, Subbarao was also for introducing certain rules to determine adequate levels of reserves. But, there is still no clarity on the exchange rate when the RBI buys dollars to build up reserves. Clearly, an institutional framework not only helps in continuity, but also removes a lot of ambiguity in financial markets.