Is the RBI ready for its own privatisation?

The RBI remains a centralised, undemocratic monolith, that refuses to transform itself according to the need of India’s highly diversified and unequal political economy.

Influenced by the philosophies of American Henry David Thoreau, and Russian Leo Tolstoy, perhaps the most important component of the Gandhian political economy must be its rejection of the ‘monolith’ nation-state. Mahatma Gandhi despised the monolith, all-encompassing government and believed in the promotion of the local economy, centred around empowered villages.

Prime Minister Modi himself has been a proponent of ‘minimum government, maximum governance’ to move toward a cooperative governance structure in India. This in a way is an extension of the decentralisation strategy presented by the erstwhile Planning Commission and preceded the infamous license raj. Despite its convoluted past, however, decentralisation still holds relevance at not only the local and central level of governance, but also at the institutional level. Not to forget, decentralisation is part of India’s economic DNA and is not out of line with its fundamental character of being a democracy.

Centralised Monolith

Nevertheless, the RBI remains a centralised, undemocratic monolith, that refuses to transform itself according to the need of India’s highly diversified and unequal political economy. As a remnant of the colonial past, the RBI has instead evolved into a glorified government department that refuses to accept the primary objective of its existence pertaining to monetary management, in entirety. By donning a regulator’s cap, the monolith RBI has established itself as an undisputed authority, operating with a sense of apotheotic impunity, having no skin in the game.

It can be argued that modern monetary management is cooperative in nature and is undertaken by a monetary system, which is in turn comprises of not only a central bank, but also other stakeholders such as commercial banks. In the RBI’s case however, the government is apparently the only stakeholder calling the shots, with the former acting as a subservient lieutenant, too eager to serve its master.

If one looks at the composition of the RBI’s Central Board, apart from the governor, the deputy governors, and a few others, most members have nothing to do with central banking, let alone hands-on commercial banking experience. Interestingly, this has always been the case and is not unique to the current government. While this kind of top-down central banking was fine until recently, perhaps not so much, given India's aspiration to be one of the world's top two economies, gradually crossing the $25 trillion threshold before 2047.

By maintaining the smallest balance sheet among major economies of the world, the monolith RBI has stifled the Indian economy in the name of inflation control for decades. By deliberately maintaining a façade of effective monetary management, through a smaller-than-usual balance sheet, RBI has forced India to reel under the weight of one of the highest ‘costs of capital’ among peers. Consequently, while the average balance sheet size among major BRICS and G7 central banks (excluding Japan) is roughly 36 percent of their respective GDPs, the RBI maintains it at just over 20 percent. Yet, the RBI’s absolute authority on the system has prevented the difficult questions. Perhaps the day of monetary reckoning has arrived.  

Reserve Bank System

This author believes that India must move beyond the centralised department, that the RBI has become, to a Reserve Bank System, that in turn composes of multiple Reserve Banks across India’s diverse regions. Here, lessons can be learnt from elsewhere in the world, most notably, the American Federal Reserve System.

By adopting Gandhian philosophy in central banking, India can evolve a monetary system that encompasses its different regions and represents key stakeholders. The idea is to develop the four ‘local boards’ located in Delhi, Mumbai, Chennai, and Kolkata, as defined by the RBI Act, 1934, into four regional Reserve Banks, each having its own governor and management board.

Moreover, the author proposes that in each of the four Reserve Banks, the government must dilute 49 percent of its equity to commercial banks and cooperative banks headquartered in each region. This would mean that 49 percent stock of Reserve Bank, Chennai, for example, will be owned by financial institutions having their head offices in southern India. The banking department component of the current Reserve Bank’s balance sheet should then be distributed among these four regional banks, with the Reserve Bank, Mumbai, retaining the issuing operations, by virtue of being the largest in the new system.

Skin In The Game

On the lines of the Federal Reserve Board, a new Reserve Bank System Board can replace the Central Board and must be composed of governors of each Reserve Bank, and representatives of major commercial banks, apart from government appointees. By involving financial institutions as stakeholders in the process of monetary management, the Reserve Bank System will create a democratic institutional set-up, that has, most importantly, skin in the game.

Theoretically, there are two extremes in central banking structures in the world. While on one end there is the case of the Bank of England, which is almost fully owned by the British Government, the Bank of Japan, is on the other end of the spectrum. This is because almost 45 percent of the Japanese central bank’s equity is publicly traded and owned by not only Japanese financial institutions but also in some cases foreign.

While the RBI already follows the structure of its former colonial master, it would be far-fetched to ideate that the government would ever allow Indian central banking to ever come close to the Japanese level of market penetration. Nevertheless, the new equity holding structure will allow Indian central banking to operate as a system instead of a standalone department-like approach.

Some might argue that through its liquidity adjustment facilities, and open market operations, the RBI is already connected to the system with an umbilical cord, the reality is that central banking in a diverse, high-growth economy needs to be far more dynamic in its approach. It is therefore time to start a debate as India’s own economic ideas are far more relevant today than a mere pastiche from the colonial past.

Karan Mehrishi is an economist, specialising in monetary economics and fixed income. Views are personal, and do not represent the stand of this publication.