Context

Modern inflation targeting central banks are often bound by explicit statutory mandates. Critics have argued that the RBI ignored its statutory inflation targeting duty.

Why transparency and predictability of the central bank is important?

• Prior to the 1990s, central banks preferred secrecy.
• Surprising market: The common wisdom was that the efficacy of monetary policy depended on taking markets by surprise.
• This belief started changing gradually with the adoption of inflation targeting.
• Influencing the inflation expectations: Targeting inflation required central banks to influence households’ and firms’ decisions.
• Thus emerged the need for central banks to be transparent and predictable.

Independence with accountability of the Central bank

• There was growing international recognition that central banks as monetary authorities should enjoy a relatively higher degree of independence from governments.
•  In a democratic polity, 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.

Regulatory governance at the RBI

• The regulatory governance discourse in India came into the focus with the report of the Financial Sector Legislative Reforms Commission in 2013.
•  Like a state, regulators usually enjoy significant legislative, 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.

Reasons for the criticism of the RBI

• Targeting exchange rate: The central bank appears to have ventured into uncharted legal territory by possibly targeting the exchange rate instead of inflation.
• Regulatory governance issues: 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 goes against an adverse Supreme Court ruling.
• Such criticisms underline an urgent need to improve the credibility of the central bank’s rule of law quotient.
• Least responsive in legislative function:  A 2019 research paper found the central bank’s legislative functions to be the least responsive in comparison to three other regulators – SEBI, TRAI and AERA.
• RBI’ss consultation papers usually presented only one solution and did not offer merits and demerits of multiple possible solutions.

Implications of weak regulatory governance: Judicial scrutiny

• Weak regulatory governance resulted in weak regulations, inviting judicial scrutiny.
• Changes in master circular: In 2019, the Supreme Court effectively rewrote RBI’s master circular on wilful defaulters to provide additional procedural safeguards to borrowers.
•  Striking down of crypto ban: 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 adduced any cogent evidence of the likely harm, nor had it considered any less intrusive alternative before issuing the circular.

RRA 2.0 suggestions for the RBI

• 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 Review Authority 2.0 (RRA) in April 2021 to streamline its regulations.
• Skill improvement in regulatory drafting: RRA has advocated for skill development in regulatory drafting inside the RBI.
• Public consultation: To improve regulatory governance at the RBI, RRA suggested that 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.
•  Although much softer than the FSRLC standards, RRA nevertheless signal a progressive step forward.

Conclusion

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.

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