Indian Financial Code: Background and Implications

Indian Financial Code: Background and Implications

Question: While Western nations are providing their central banks with more authority and regulatory powers, India is working towards reducing the powers of the RBI through the New Financial Code. Discuss.

- Certain countries in the West are giving central banks more authority as well as regulatory powers

- India has proposed the New Financial Code to curtail the powers of the RBI

- Proposed creation of the Monetary Policy Committee is to be resolved for matters related to monetary policy

Background

Financial Sector Legislative Reforms Commission established by the Centre in 2011 submitted reports in 2013

- Commission proposed a draft Indian Financial Code based on analysis

- Plus points of IFC-1 were its emphasis on consumer protection, independence of regulators such as RBI and proposed Public Debt Management Agency

- Negative points include attempt to repeal 15 major legislations

- A focused project team was also formed to manage the transition process

IFC-2

- Following the release of IFC-1, IFC-2 was released in 2015 on 23rd July and finalised by 8th August 2015.

Modifications in IFC-2 revolve around the following:

- Rule Making

- Operational Aspects of Capital Controls

- Monetary Policy Framework

- Composition of Monetary Policy Committee

- Provisions pertaining to PDMA were also revised

- IFC-2 recommended repealing of 19 existing legislations

Objective of IFC-2 has been framed again to provide equivalent importance to inflation and growth

- Inflation for each target financial year will be determined through Consumer Price Index through the central government in consultation with the RBI every 3 years

- Composition of MPC has been tilted in favour of the union government in ratio 4:3(excluding the direct nominee of the Union government who will not vote in both IFCs)

- A second vote has been cast in event of tie in MPC decision

- Accountability mechanism has been put in place defining failure to meet inflation objective of monetary policy and reporting requirement giving an explanation of the circumstances of failure and remedial measures

- Reserve or overriding power of the central government has been eliminated which is a positive feature enhancing RBI independence

- Overriding power of the central government has now been moved to the MPC

Implications of IFC-2

- Proposed MPC comprising 7 members, major portion of which are to be nominated by the government, take over from the RBI in all aspects of monetary policy

- This includes setting of interest rates

- Potential for conflict of interest is vast as there will have be a tradeoff between inflation and growth

- RBI’s prime power includes monetary policies and maintenance of financial stability, supervision and regulation of banks as well as NBFCs

- India’s foreign exchange has been accumulated and maintained by RBI and the the central bank is the apex institution when it concerns payment and settlement systems in the nation

- No clarity is prevalent in IFC-2 regarding foreign exchange reserves control by RBI

- Some found for conflict also exists with respect to NBFCs

- IFC defines the bank as a financial services provider and accordingly NBFCs will become banks creating the question of whether RBI or financial authority will be resulting them

Facts and Stats

- IFC has envisaged the creation of Financial Stability and Development Council

- Other bodies include Public Debt Management Agency and Resolution Corporation taking over the role of DICGC

- IFC-2 is also looking to amalgamate financial regulatory agencies into a proposed financial authority deeming the RBI as one of the financial agencies with the Governor and Deputy Governors being designated as Chairman and members