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Last Updated : Aug 16, 2019 02:45 PM IST | Source:

Policy | Who regulates public sector banks: Government or RBI?

The web of the finance ministry and the RBI on regulation of PSBs is making things murkier.

Moneycontrol Contributor @moneycontrolcom

Amol Agrawal

It has been a long-standing question, but analysts are split in their views – who holds the levers of control when it comes to public sector banks (PSBs)?

Well, RBI former governor Urjit Patel did speak his mind when in a speech titled Banking Regulatory Powers Should Be Ownership Neutral in March 2018, he argued that though the RBI is the banking regulator, the powers to regulate PSBs are held by the government. The Government of India (GoI) regulates PSBs under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970; the Bank Nationalisation Act, 1980, and the State Bank of India Act, 1955.


Patel argued that Section 51 of the Banking Regulation Act (1949) explicitly states that the RBI does not have powers on critical aspects of governance in the PSBs. These are: The RBI cannot remove chaipersons, managing directors or directors of a PSB; the central bank cannot force a merger or liquidation in the case of the PSBs; the PSBs neither require licence from the top bank nor can it revoke their licence.

As the PSBs continue to dominate the banking space as their assets comprise two-thirds of total banking assets — though the space has shrunk over the years — this also implies that RBI barely regulates one-third of the banking sector.

This duality of control of banks has made things lopsided when it comes to governance of Indian banks. The RBI can issue guidelines to private banks or foreign banks, but not to the PSBs. The PSBs enjoy not just sovereign guarantee, but also escape RBI regulations on critical matters. Thus, there is only so much the RBI can do when it comes to cleaning up banking in India.

The speech created a fair bit of discussion in the media with people arguing both in favour and against the speech. Those who argued against suggested that RBI was trying to absolve itself from the ongoing banking crisis. RBI has had its own representative on the board of these banks and they should have been aware of the ongoing problems.

Those for the speech said this is an old problem which needs a resolution. RBI was given full powers to regulate banks under the Banking Regulation Act, but these powers were diluted. After the nationalisation of SBI and of 20 PSBs (14 in 1969 and 6 in 1980), these powers were diluted, as argued by Patel in his speech. The FSLRC  (Financial Sector Legislative Reforms Commission) report had also argued that “laws relating to banking should be ownership neutral and should provide a level playing field for all banks”.

The PJ Nayak Committee report (2014) on governance in banks had also pointed out that the PSBs suffer from several constraints such as dual regulation, board constitution, difficulty in categorising any director as independent and growing differences with private banks in skills and salary levels.

Despite all these reports, this dual control not just continues, but makes things even complex. The web of the finance ministry and RBI on regulation of the PSBs is making things murkier.

Take the case of the Finance Bill presented in the Union Budget for 2019-20. One of the provisions was to change the Banking Companies Act, 1970. Section 9(a) of the Act specified that the government could appoint “not more than four whole-time directors”, which has been increased to “not more than five whole-time directors”. The original Act in 1970 specified that the board will have seven directors, of which two could be appointed by the government which was raised to four in 2006. In all these appointments, the RBI acts as advisor to the government.

In 2006, it was decided that the RBI would define ‘fit and proper’ status of these directors. The PSBs were required to constitute a ‘nomination committee’ consisting of a minimum of three directors (all independent/non-executive directors) from among the board of directors. This panel was required to do a due diligence of the candidates to be chosen as directors.

At that time, it had broadly listed three criteria: Educational qualification, experience and field of expertise, and track record and integrity. The area of expertise involves special knowledge in fields such as banking, economics, agriculture, law, and small scale industry. In 2016, RBI added more fields in line with changing times: information technology, payment and settlement systems, human resources, risk management and business management.

RBI recently (August 2) updated this fit and proper criteria adding the age factor (35-67 years) and at least a graduate in education. Earlier, disqualification of directors was vague, but now it has been prescribed. The candidate should not be a board member in other banks, NBFCs, financial Institutions and insurance companies. She should not hold any government position such as an MP or that of a state legislature and not engage in broking business. She should not be a partner of a chartered accountant firm which is either auditing the PSBs or their branches. In a 2006 decision, RBI had allowed the nomination committee to fix the tenure which has now been set at three years (which is too short) and can be renewed but not allowed to serve more than six years — continuously or intermittently.

So, there is no doubt that we need clarity in banking regulatory powers. Ideally, the banking watchdog should be handling all regulations, whether it is the PSBs or private banks. The dual control and regulation with a plethora of laws leads to only ambiguity and difficulty in fixing accountability. This lack of accountability is one of the key reasons for inability to resolve banking crisis not just in India, but worldwide too.

We should go beyond recapitalising the PSBs and fix this dual control of banks. This removal of dual control is not even a reform, but something absolutely basic to efficient functioning of the banking system in the country. Yet, it continues to be ignored despite being suggested by a few committee reports and the former governor.

Amol Agrawal is faculty at Ahmedabad University. Views expressed are personal.

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First Published on Aug 16, 2019 02:45 pm
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