Building a specialised supervisory cadre at the central bank

During the RBI board meeting held in May 2019, the central bank announced creating a specialised supervisory and regulatory cadre. The board noted the growing complexities and interconnectedness of the financial sector and wished to strengthen the regulation and supervision of commercial banks, urban cooperative banks and non-banking financial companies (NBFCs). In the June 2019 monetary policy, RBI Governor Shaktikanta Das termed this as a “major decision”.

This is welcome news but what is not clear is the additional roles this cadre will play. The RBI already has two separate departments for this purpose: Department of Banking Regulation (DBR) and Department of Banking Supervision (DBS). The DBR, as the name suggests, looks at the overall functions of banking regulation that include licensing, branch expansion, maintenance of statutory reserves, operations, amalgamation, reconstruction and liquidation of banking companies. The DBS, on the other hand, deals with on-site and off-site surveillance of banks. Likewise, there are separate departments for cooperatives supervision and regulation and another department for non-banking regulation.

The history of how the RBI has organised itself over time to deal with banking regulation is quite interesting. At the time of the inception of the RBI, banks were governed by the Indian Companies Act (1913), which did not define banking but had certain provisions that allowed a firm to be called a bank. Thus, the first task of the RBI was to provide a definition of a bank. Under the amendment in Indian Companies Act, a bank was defined as “a company which carries on as its principal business the accepting of deposits of money on current account or otherwise, subject to withdrawal by cheque, draft or order”. The amendment also prescribed a minimum paid-up capital of Rs 50,000 for banks and a cash-reserve ratio on the bank’s deposits. 

Despite these changes, the RBI top brass wished for a comprehensive banking regulation. The wishes became an urgency as the failure of Travancore and Quilon Bank (formed by the merger of Travancore National Bank and Quilon Bank) in 1938 exposed the inadequacy of the banking laws and governance. The RBI studied banking laws in several countries such as Canada, Australia, the US etc and proposed large-scale changes to the government. The proposals were delayed due to World War II and then India’s Independence. Most of these proposals became part of Banking Regulation Act (1949) that specified only banking firms should use the word bank and gave the RBI powers to inspect banks at will. 
Lack of supervision It would have been much better if the RBI’s central board had highlighted where the existing departments fell short and then suggested a remedy
Institutionally, the RBI had established Department of Banking Operations (DBO) in 1945 to deal with all banking problems and inspection. In 1950, it established Department of Banking Development (DBD) following suggestions of Rural Banking Committee. Both DBO and DBD were very powerful departments in the early part of the RBI’s history. The two were merged in 1965 to become the all-powerful Department of Banking Operations and Development or DBOD as financial market participants would call mostly with fear. In 1966, the RBI established a separate Department of Non-Banking Companies for regulating the NBFC sector. 

Post the reforms of 1991, there were two more changes. The Narasimham Committee on financial sector reforms suggested streamlining of regulation and supervision which had become over-regulated and over-administered. It proposed separating the supervision function from other functions of the RBI and establishing a quasi-autonomous Banking Supervisory Board under the aegis of the RBI. The board would supervise not just banks but also NBFCs and development financial institutions. The board would be chaired by the governor and have three members drawn from different fields and one representative from the government. Accordingly, then finance minister Manmohan Singh announced establishing a Board of Financial Supervision in his Budget speech of 1993-94. The RBI also established a new Department of Financial Supervision to aid the BFS. However, the composition of BFS was different with four members drawn from the central board of the RBI. Over time, the scope of BFS was enlarged to include cooperatives, RRBs and primary dealers. 

In 2014, the RBI made a Committee on Organisational Restructuring of the Reserve Bank (Chair: Deepak Mohanty). Based on the Committees’ suggestions, the name of DBOD was changed to DBR (name of Rural Planning and Credit Department (RPCD) was also changed to Financial Inclusion and Development Department (FIDD). The RBI also separated the regulation and supervision tasks and placed DBR and DBS separately under two deputy governors and executive directors.

It is also interesting to note that RBI is not the lone central bank here. Before the crisis, central banks mainly looked at monetary policy and banking supervision was either delegated to a separate agency or demoted to a lower role. After the crisis, this thinking has reversed significantly. The US Federal Reserve now has a vice-chairperson for supervision (currently Randal Quarles) and releases a separate report on supervision and regulation. The European Central Bank is building a single supervision board (SSB), whose purpose is to build a harmonious system of banking supervision across member economies. The vice-chair of SSB is from the ECB’s executive board and ECB separately nominates four members to the board (currently all positions are vacant barring one). The Bank of England is behind Prudential Regulatory Authority (PRA), which regulates and supervises around 1,500 banks, building societies, credit unions, insurers and major investment firms. Of the four deputy governors, one is CEO of PRA (currently Sam Woods). 

These are interesting times for central banks. They have for long obsessed with monetary policy and sidelined the more basic function of banking supervision. The blame for the ongoing banking crises lies not just with bankers but also with the supervisors. Critics might say we have had banking regulation for ages now and new regulations will hardly help. However, what we are talking about is supervision, which is different. Regulation is writing rules and supervision is enforcing them. In fact, most banking policy action is around regulation and less about supervision. 

Having said that, in the RBI’s case, banking supervision has always been part of its DNA. It would have been much better if the RBI’s central board had highlighted where the existing departments fell short and then suggested a remedy. Critics have pointed to the RBI’s lack of supervision in the ongoing NPA crisis and fraud cases. Hopefully, the central bank will clarify the role of this new cadre and how it is going to add value to the RBI and the Indian banking system.

The author is a faculty at Ahmedabad University and writes a blog, Mostly Economics

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