Pratik Datta writes: Policy, not diktat

James Carville, a political advisor to Bill Clinton, had famously quipped that if there were such a thing as reincarnation, he would like to come back as the bond market because you can intimidate everyone. Reincarnation as the central bank wouldn’t be any less exciting. After all, they are the “only game in town”. The rule of law appears rather staid in comparison, but the law is fast catching up.

Modern inflation targeting central banks are often bound by explicit statutory mandates. Spiralling inflation is therefore likely to bring the law into sharp focus. This phenomenon is currently playing out in India. Critics have argued that the RBI ignored its statutory inflation targeting duty. The central bank appears to have ventured into uncharted legal territory by possibly targeting the exchange rate instead.

Separately, critics have also highlighted broader regulatory governance challenges at the RBI. For instance, its alleged use of informal nudges to restrict a foreign player’s access to the Indian payment ecosystem appears to fly in the face of an adverse Supreme Court ruling. Another recent instruction abruptly prohibiting loading of prepaid instruments from credit lines has been criticized for causing confusion among market participants. Such criticisms underline an urgent need to improve the credibility of the central bank’s rule of law quotient.

In this context, the recent report of the Regulations Review Authority 2.0 (RRA) offers useful suggestions to improve the central bank’s regulation-making process. The RBI had set up the RRA in April 2021 to streamline its regulations. The RRA has recognised that preparation of regulatory or supervisory instructions is akin to drafting, which is both an art and science. It has therefore advocated for skill development in regulatory drafting inside the RBI.

The RRA has also made several important suggestions to improve regulatory governance at the RBI. For instance, its regulatory instructions should be issued only after public consultation, except if they are urgent or time sensitive. They must contain a brief statement of objects and reasons clearly explaining the rationale behind their issuance. They must be accompanied by a press release with the necessary background, brief rationale, and objective of the regulatory prescription. Finally, a structured mechanism for periodic review of the RBI’s regulations has also been suggested.

These seemingly straightforward suggestions hold great significance for a central bank. Prior to the 1990s, central banks thrived on secrecy. The common wisdom was the efficacy of monetary policy depended on taking markets by surprise. This belief started changing gradually with the adoption of inflation targeting. Targeting inflation required central banks to influence households’ and firms’ decisions. This could be done better by transparently communicating with them rather than surprising them. Thus emerged the need for central banks to be transparent and predictable.

During the same period, there was growing international recognition that central banks as monetary authorities should enjoy a relatively higher degree of de facto or de jure independence from their elected governments. In a democratic policy, this could only be expected in exchange for increased accountability. As a result, regulatory governance gradually emerged as a relevant consideration for independent central banks over the last three decades.

The regulatory governance discourse in India gained salience with the report of the Financial Sector Legislative Reforms Commission in 2013. It considered statutory regulators to be mini-states. Like a state, regulators usually enjoy significant, executive and judicial powers and should be subject to appropriate accountability mechanisms. These should include internal separation of powers; a well-structured regulation making process overseen by the board, through public consultation and cost-benefit analysis; duty to explain its actions to regulated entities and public at large; regular reporting requirements; and judicial review. Based on these recommendations, the Ministry of Finance released a handbook in 2013 for voluntary adoption of these enhanced governance standards by all financial sector regulators.

These developments turned the spotlight on the RBI’s regulatory governance. A 2019 research paper authored by Anirudh Burman and Bhargavi Zaveri found the central bank’s functions to be the least responsive in comparison to three other regulators – SEBI, TRAI and AERA. During the period under study – January 1, 2014 to April 30, 2016 – the RBI held formal public consultations for only 2 per cent of all instruments it issued.

Its consultation papers usually presented only one solution and did not offer merits and demerits of multiple possible solutions. The paper attributed this low responsiveness to deficiencies in the formal legal framework.

Weak regulatory governance resulted in weak regulations, inviting judicial scrutiny. In 2019, the Supreme Court effectively rewrote RBI’s master circular on wilful defaulters to provide additional procedural safeguards to borrowers. In 2020, the court struck down an RBI circular that sought to ban its regulated entities from dealing or settling in virtual currencies. The court found that the RBI had neither added any cogent evidence of the likely harm, nor had it considered any less intrusive alternative before issuing the circular. Accordingly, the circular was held to be a disproportionate restriction on the fundamental right to conduct business in India.

Against this backdrop, the RRA’s recommendations assume significance. Although much softer than the FSRLC standards, they nevertheless signal a progressive step forward. Unlike the FSLRC or the Ministry of Finance, the RRA was a serving RBI Deputy Governor. Its recommendations would hopefully find greater acceptance within the central bank.

The RBI should heed these recommendations. It should ideally hardcode the suggested principles into a secondary legislation that is binding on itself. That would be the best way to signal that the central bank takes regulatory governance and rule of law seriously.

Datta is a Senior Research Fellow at Shardul Amarchand Mangaldas & Co., New Delhi. Views are personal


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