Section 7: Why The Government Took This Step Against the RBI

November 21, 2018
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Recently national media of India reported a somewhat unusual occurrence – the central government, for the very first time in history used Section 7 of the RBI act. This unprecedented move has scholars and analysts are expressing their concerns over its repercussions. Before delving into the reasons for this occurrence, let’s consider what the section 7 of RBI Act is about.

Section 7 of RBI Act

The Reserve Bank of India was established in 1935. RBI operates in accordance with the Reserve Bank of India Act,1934. In general, RBI is an independent institution which takes decisions on its own. The government has a very little role in the decision-making process of the Indian central bank. However, there are some provisions in the RBI Act which enable the government to interfere with the decisions of RBI. These provisions are contained in section 7 of the act.

According to section 7 of the RBI Act, the central government can give directions to the Bank in the consideration of public interest. Subject to any such directions, the general superintendence and direction of the operations and business of the Bank shall be consigned to a Central Board of Directors which may exercise all authorities and do all acts and things which may be executed or done by the Banking courses and tools. 

Clearly, this section authorises the central government to issue directions in public interest to RBI. But It should be noted that since the time of its creation, such an incident has never happened.

Why Section 7 Was Invoked

RBI and government have been at loggerheads for a while now. The government wanted to ease the lending rules for banks under the prompt corrective action (PCA) framework. This move was aimed to reduce the pressure on Micro, Small and Medium Enterprises (MSMEs). But, the bank believed that such a move would result in the undoing of all the clean-up efforts. The dispute over the liquidity of NBFCs was another chapter in this series. The government wanted to increase the liquidity for NBFCs. But, the RBI insisted on keeping the same level since the banking system was maintaining steady borrowing costs. The media reported that government and RBI were having disagreements over huge number other important issues too. Classification of non-performing assets and setting up a payments regulator independent of RBI were some of the other issues that were bones of contention.

While this tension was building up, a court order was issued allowing the government to consider giving directions to RBI under section 7 of RBI Act in a case related to independent power producers. This instantly opened a path for the central government to go around the RBIs opinion and initiate their wishes.

This part of the RBI Act survived the dark days of 1991 and the global crisis of 2008 without being invoked. There are many scholars with an opinion that such an intervention from the government will not only set a lax precedent for further governmental influence, but also worry that the RBI’s decisions have come to be disvalued. They also believe that the autonomy of the Reserve Bank should be kept consistent.

While the government might have made these bold decisions in the belief that the changes requested to the RBI’s modus operandi might have positive impact on businesses and therefore the citizens, the far-reaching consequences of this action are yet to be determined.

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