Section 7 of RBI Act and Its Implications

Section 7 of RBI Act 1934 is a provision in that authorizes the Central government in India to issue directions to RBI. Section 7 of RBI Act came into limelight due to reports that the Central government invoked the powers conferred on it by the clause. So far in the history of India, there has been any instance of the Central government invoking Section 7 of RBI Act, as the same is treated as an extreme step. Reports suggest that the Central government issued several letters under the powers of Section 7 to the Reserve Bank Governor on various issues. The issues include easing the norms related to Prompt Corrective Action (PCA) framework of RBI, improving liquidity to tide over the liquidity crunch being faced by NBFCs consequent to IL &FS default, transferring dividend by RBI  and lending  to Micro, Small and Medium Enterprises (MSMEs).

Relevance of section 7 of RBI Act

Reserve Bank of India was established on April 1, 1935 in terms of the provisions of  Reserve Bank of India Act 1934 (RBI Act 1934). After independence, RBI continued as the Central Bank of India. After nationalization in 1949, the RBI which was originally owned privately became fully owned by the government. But, RBI is independent of the government and is empowered to take its own decisions. However, RBI is made to listen to the Central government under certain circumstances and the related provisions are covered in Section 7 of the RBI Act. Section 7 empowers government to give directions to RBI under exceptional circumstances in public interest.  The provisions under Section 7 states as follows:

(1) The Central Government may from time to time give such directions to the Bank as it may, after consultation with the Governor of the Bank, consider necessary in the public interest. 
(2) Subject to any such directions, the general superintendence and direction of the affairs and business of the Bank shall be entrusted to a Central Board of Directors which may exercise all powers and do all acts and things which may be exercised or done by the Bank. 
(3) Save as otherwise provided in regulations made by the Central Board, the Governor and in his absence the Deputy Governor nominated by him in this behalf, shall also have powers of general superintendence and direction of the affairs and the business of the Bank, and may exercise all powers and do all acts and things which may be exercised or done by the Bank.

RBI normally does not seek the views of Government in monetary matters, but is bound to obey the Government on the directions in public interest issued to  the central bank under provisions of Section 7. 

What provoked government to invoke section 7 of RBI Act? 

The views of government and RBI have been differing on solution to certain issues that emerged in recent past. 
1.    RBI has been taking stern actions against banks with poor balance sheet strengths in terms of capital, asset quality and ROA. However, Government has been seeing this action as a hindrance to credit growth. According to government, MSMEs are suffering as banks under PCA are not permitted to lend as in usual course. RBI is of the view that clean-up is essential for long term sustenance. 
2.    Consequent to the failure of IL&FS to honor their financial commitments, NBFCs have been facing liquidity issues. For them, the interest rate also went up. The government feared this to lead to more defaults from NBFCs. RBI did not subscribe to this and has been pointing out that there is neither liquidity crisis nor interest rate spike in the market.     
3.    Vide circular dated February 12, 2018 RBI instructed banks to consider borrowers missing payment even for a day as  defaulter and initiate remedial measures, even though  the said accounts continue as standards. Aggrieved by this, power producers approached court and a recent court verdict suggested government to consider giving directions to RBI under Section 7.   
4.    RBI and government also had differing views on setting up payments regulator independent of RBI.  
5.    The Government demanded RBI to transfer rupees 3.25 lakh crores from its reserves as dividend to government to reduce the fiscal deficit. RBI is not willing to transfer the same as it is preserved for meeting emergency situations.  

Implications of invoking Section 7 of RBI Act

In the history of India, no government has invoked the powers under section 7 as it is seen as interference in the freedom of RBI’s decision making. This route was not explored in 1991 when the country was close to default or during the period of global financial crisis in 2008. The present moves of the government and differing views have made market and independent observers doubt the real intentions of the government. According to large section of economic experts, autonomy of central bank is a pre-condition for long term financial stability of the country and attracting foreign investments. Any action under Section 7, may affect the credibility of the country and financial sector.