• The Central government is invoking a never – before – used power under the RBI act. One that allows it to issue directions to the central bank Governor on matters of public interest.
• Given that the RBI as the central bank is intended to be an autonomous institution. This is an unusual departure from the norm.
• The government can issue directions to the RBI under section 7 of the RBI act. In recent weeks the government is reported to have sent several letters to the RBI governor on several issues, ranging from liquidity for non – banking financial companies to capital requirements of weak banks and lending to micro, small and medium enterprises.

Government Invoked Section 7

• “The Autonomy of the central bank, within the frame work of the RBI act, is an essential and accepted governance requirement.
• Both the government and the RBI, in their functioning, have to be guided by public interest and the requirement of the Indian economy.
• For this purpose, extensive consultations on several issues take place between the government and the RBI from time to time”.

RBI vs CENTRE:

• Government wrote three letters to RBI in past few weeks.
• First letter to carve out exemption for power companies under PCA framework.
• Government view that easing lending rules for banks under PCA could help reduce pressure on MSME.
• RBI argued such a more would undo clean-up efforts.
• Second letter pertained to use of RBI capital reserves for Providing liquidity to market.
• Third letter for relaxing constraints on banks for loans to SME,
• Government for lowering interest rates, RBI opposed to it.
• RBI deputy collector made disagreement with government public in hard -hitting speech.
• Viral acharya blamed government for interfering with RBI working.
• Finance Minister Arun Jaitley accused RBI for bad loan crisis.

Section 7 of RBI Act:

• RBI drafted provisions combining provisions of bank of England Act, 1946 and common wealth bank of Australia, 1945.
• Provisions on central government’s powers to issue directions to central bank.
• RBI suggested the act make it clear that government take responsibility when it acts against Governor’s Advice. Government not in favour of Provision then, clause re-drafted.
• Section 7 amended in 1949 to empower centre to issue directions to RBI in public interest.

Sections and what they deal with:

• Section 3: Establishment and incorporation of the Reserve Bank
• Section 4: Capital of the Bank Fixed at Rs 5 Crore.
• Section 8: Composition of Central board of the RBI.
• Section 17: Business to be carried out by the RBI.
• Section 18: Emergency loans to bank.
• Section 21: RBI must conduct banking affairs for central government and manage public debt.
• Section 22: RBI has exclusive rights to issue currency notes in India.
• Section 24: Denominations of currency.
• Section 42: Cash reserves of scheduled bank to be kept with the bank.
• Section 45 (U): Defines repo, reverse repo, derivative, money market instrument and securities.
• First Schedule lists areas under which states fall
  • Western Area
  • Eastern Area
  • Northern Area
  • Southern Area
• Second schedule lists all scheduled banks in India

Section 7

• The Central Government may from time to time give such directions to the bank as it may, after consultations with the governor of the Bank, consider necessary in the public interest.
• Subject to directions, general superintendence and direction of the affairs and business of the bank shall be entrusted to a central board of directors which may exercise all powers and do all acts and things which may be exercised or done by the bank unless otherwise provided in regulations made by the central board, the Governor and in his absence the Deputy Governor nominated by him in his behalf, shall also have of general superindence and direction of the affairs and the business of the world bank. And may exercise all powers and do all acts and things which may be exercised or done by the bank.

Functions of RBI:

• Regulating the issue of bank notes and keeping of reserves to secure monetary stability and operated India’s currency and credit system.
• Maintain a modern monetary policy framework to maintain price stability while keeping in mind the objective of growth.
• Governed by central board of directors appointed by government for 4 years.
• Full – time officials are governor and not more than four Deputy Governor.

Traditional functions:

• Note Issue, banker, Agent and Financial adviser to the government acts as a guardian for commercial banks, custodian of Forex.

Supervisory Functions:

• Supervises banks and promote sound banking in India.
• Grant licenses to the bank. Functions of inspection and enquiry.

RBI’s Instrument:

• Repo Rate: Rate at which RBI lends short – term money to banks against securities.
• When repo rate increases, borrowing from RBI decreases (Expensive)
• Reverse Repo Rate: Rate at which RBI borrows money from banks.
• Banks purchase government securities from RBI and land money to the banking regulator, thus earning interest.

Marginal standing Facility:

• Introduced in 2011-12, MSF is a penal rate for banks.
• Banks can borrow funds by pledging government securities within the limits of the SLR.