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Wednesday, January 25, 2017

How would demonetisation have shaped up under an improved RBI board?

by Bhargavi Zaveri.

Demonetisation has brought fresh attention to three aspects of RBI's board: autonomy, accountability and transparency. Patnaik and Roy (2017) demonstrate how the RBI Act lags behind sound international practices on these three counts.

The main financial reforms process in India has been the gradual enactment of the draft Indian Financial Code (IFC) drafted by Justice Srikrishna's Financial Sector Legislative Reforms Commission (FSLRC). In this article, we refer to version 1.1 of the IFC.

FSLRC strongly emphasised resolving deeper public administration problems that have bedeviled State capacity in India. One would assume that IFC solves many flaws in the functioning of the RBI's board which have been revealed in the demonetisation episode. However, both the FSLRC report and IFC have been previously criticised for undermining RBI's autonomy. After the demonetisation event, the IFC has been criticised for recommending a smaller RBI board.

In this article, using information available in public domain, we try to piece together what transpired at the RBI board when the decision to demonetise 86% of the currency in circulation was taken. We compare the RBI Act against the IFC. We play a `war game' of thinking through the demonetisation drama under the IFC, and examine the extent to which IFC might have produced a stronger and more capable RBI. This war gaming sheds new light on how to create State capacity in India.

What was the role of the RBI Central Board in the demonetisation decision?

The notification demonetising the currency notes of Rs. 500 and Rs. 1000 was issued pursuant to the recommendation of the RBI Central Board (hereafter, RBI Board). The RBI refused to disclose the minutes of the meeting where the RBI board decided to recommend the demonetisation decision to the Central Government. However, a response given by RBI to a RTI query reveals the following:

  1. The recommendation was made in a meeting of the RBI Board held on 8th November, 2016.
  2. When the meeting was held, some of the seats on the board were vacant and some of the members did not attend. Table 1 gives an overview of the RBI board composition and attendance at the meeting held on 8th November, 2016:

    Table 1: Board composition and attendance at the meeting held on 8th November, 2016
    Sanctioned Appointed Number of members who attended the meeting Number of votes allowed to be cast at the meeting
    Governor 1 1 1 1 (plus a casting vote in case of equal votes)
    Deputy Governors 4 3 2 0
    Directors of local RBI Board 4 1 1 1

    Independent Directors*

    10 3 2 2
    Nominees of the Central Government 2 2 2 0
    Total 21 10 8 4 (plus Governor's casting vote)

    *Independent directors are employees of neither the Central Government nor the RBI.

    Under the RBI Act, only the Governor, the members of local RBI boards and independent directors are allowed to vote at meetings (Section 8(3), RBI Act). Table 1 indicates that out of the maximum sanctioned strength of 21, 11 seats were vacant on November 8, 2017. Out of the 10 appointed members, 8 members attended the meetings, and only 4 of them could vote. Amongst the voting members, 2 were independent members. There has been no public disclosure about voting by the members present on 8th November, 2016.

Composition of the RBI Board: RBI Act vs. IFC

RBI has a (a) central board comprising of Governors and Deputy Governors and (b) four regional boards. One member, to be nominated by the Central Government, from each of the regional RBI boards is a member of the RBI Central Board. The discourse faults FSLRC for having abolished the regional RBI boards, and downsizing the RBI Central Board. Table 2 compares the provisions of the RBI Act and IFC on board composition.

Table 2: Comparing Board constitution
Feature Under the RBI Act Under IFC
What is the size of the RBI Board? Minimum 17, Maximum 21 (Section 8, RBI Act) Minimum 6, Maximum 12 (Section 10, IFC)
How many full-time members does the RBI Board have? Minimum 1, maximum 5, that is, Governor and a maximum of 4 Deputy Governors (Section 8, RBI Act) Not more than half the size of the current board (Section 10, IFC)
How many directors of local RBI boards are members of the RBI Board? 4 (Section 8, RBI Act) NA
How many nominees of the Central Government, does the RBI Board have? 2 (Section 8, RBI Act) Minimum 1, maximum 2 (Section 10, IFC)
How many independent members does the RBI Board have? 10 (Section 8, RBI Act) The balance remaining after filling the seats (Section 9, IFC)

Table 2 shows that under IFC, regulatory power and accountability are centralised in the RBI Board, as opposed to dividing it between a central board and local boards. Thus, there is one board that is empowered to carry out all the actions of RBI and accountable for the entire financial agency. Also, while the overall board strength has been reduced, IFC imposes a cap on the number of members who are not independent directors. Assuming the full strength of the board, today's RBI Board has more "independent members" as compared to the FSLRC recommendations. There are three takeaways from this:

  1. Popular discourse has faulted the IFC for making the RBI Board vulnerable to Central Government's influence. Table 2 shows that on the contrary, the provisions governing board composition in IFC have tilted the board strength towards members of the board who are RBI employees.
  2. Despite a large sanctioned strength and being overloaded with independent directors, the RBI board is now being accused of having not exercised sufficient independent discretion at the meeting held on 8th November, 2016. Thus, the sheer board size did not have the intended outcomes.
  3. Modern thinking on the size of committees and boards suggests that a size range of 17 to 21 is excessive. It is likely to create a greater free rider problem and inferior discussions.

Consequences of not filling up vacancies on the board: RBI Act vs. IFC

The obligation to fill up vacancies on regulatory boards is crucial. The board-size becomes moot if the seats of independent directors are vacant. At the time the decision was taken by the RBI Board, only 3 out of the 10 independent members were appointed. Table 3 compares the provisions of the RBI Act and IFC on the consequences of not filling up vacancies on regulatory boards.

Table 3: Vacancies on the RBI board
Feature Under the RBI Act Under IFC
Time-limit for filling vacancies on the RBI board None Vacancy must be filled within (a) 15 days from the date on which the vacancy arose, where the board-size falls below 6; and (b) 180 days from the date on which the vacancy arose, in all other cases. (Section 25, IFC)
Consequence of the Central Government not appointing independent directors on the board of RBI None Central Government to prepare a report within 90 days from the expiry of the timelimit, stating the reasons for the failure; and lay it before Parliament in an ongoing session or where the Parliament is not in session, in the immediately next session. (Section 25, IFC)

Meetings of the RBI board: RBI Act vs. IFC

Decision-making by members of a board is inherently connected with the way meetings are convened and conducted. Table 4 gives a comparative overview of the provisions in the RBI Act and IFC governing the conduct of meetings of the RBI Board.

Table 4: Convening and conduct of meetings of RBI board
Feature Under the RBI Act Under IFC
Notice for convening board meetings 1 month (Regulation 8, RBI General Regulations, 1949) 7 days. (Schedule 2, IFC)
Can a meeting be convened at shorter notice? Yes, with sufficient notice to be given to every Director who is in India to enable him to attend (Regulation 8, RBI General Regulations, 1949) Meetings may be convened in special circumstances with shorter notice, provided the special circumstances are recorded in writing at the meeting. (Schedule 2, IFC)
Can members request the Governor for a meeting to be convened? Yes, 4 members may request a meeting to be convened (Section 13, RBI Act) Yes, 2 members may a request a meeting to be convened (Schedule 2, IFC)
What if the Governor does not convene a meeting at the request of the members? No implication (Section 13, RBI Act) Members may convene the meeting without the Governor. (Schedule 2, IFC)
Can quorum be constituted without independent members? Yes (Regulation 8, RBI General Regulations) Yes (Schedule 2, IFC)
Who is entitled to vote at meetings? Only the Governor, the directors of local boards and the independent members. (Section 8, RBI Act) All members are entitled to vote at meetings of the RBI board. (Section 26, IFC)
Can members attend meetings through technological means? Yes (Regulation 10A, RBI General Regulations) Subject to physical attendance at atleast one meeting a year, yes (Schedule 2, IFC)

There are four main takeaways from Table 4:

  1. First, both IFC and the RBI Act are lacking in the details to be furnished to members of regulatory boards before the meeting is convened or at the time the meeting is held. Unlike commonly accepted secretarial standards which require an agenda and notes on each proposal tabled at a meeting of corporate boards, the laws governing regulators do not elaborate these requirements. Presumably, this has been left to the regulator's bye-laws which governs the internal affairs of regulators.
  2. Second, again, contrary to popular perception, IFC vests more voting power in the full-time members of the RBI board, as compared to the RBI Act. It puts all board members at par with each other, in so far as their voting rights are concerned.
  3. Third, while IFC requires a shorter notice to be given for meetings, as compared to the RBI Act, it has more robust processes for convening meetings at notice shorter than that required under law, including recording reasons for such shorter notice.
  4. Under both the RBI Act and IFC, the quorum can be constituted without independent members. This is problematic and needs further deliberation.

Relationship between the RBI and the Central Government: RBI Act vs. IFC

The way the relationship between the Central Government and the RBI is codified in the law, can hamper or increase the independence of regulators. Table 5 gives a comparative overview of this relationship, as codified in the RBI Act and IFC.

Table 5: Relationship between the Central Government and the RBI Board
Feature Under the RBI Act Under IFC
Can the Central Government give directions to the RBI board? Yes (Section 7, RBI Act) No.
Can the Central Government supersede the RBI Board? Yes (Section 30, RBI Act) No
Can the Central Government remove any member of the RBI Board? Yes (Section 11, RBI Act) Yes, on the limited grounds specified in the law (Section 22, RBI Act)
What is the process for removal of a member of the RBI Board? The law does not specify any process. The process involves a hearing before an inquiry committee comprising judges of the Supreme Court and a High Court and experts in the field of finance (Section 23, IFC)

Table 5 indicates that the IFC has provided for an arms' length relationship between the Central Government and the RBI. While the RBI Act gives considerable powers to the Central Government to supersede the board and issue directions to members of the RBI Board, such powers are absent from IFC. To be clear, it is nobody's case that the Central Government had used its direction-making powers under the RBI Act in connection with the demonetisation decision. However, being de jure indicators of independence, they are necessary though not sufficient conditions for ensuring independence.

Internal and external accountability mechanisms: RBI Act vs. IFC

Accountability can be ex-ante or ex-post. Ex-ante mechanisms comprise of processes which must precede the performance of any function. IFC requires all quasi-legislative instruments to be issued through a robust regulation-making process comprising a cost-benefit analysis and a public consultation process. It requires the RBI Board to review regulations made after every three years. These measures are absent from in the RBI Act.

As regards executive and quasi-judicial functions, IFC provides for a time-bound licensing process, specific grounds for rejection of licenses, an administative law wing that is independent of the other departments of the RBI, for taking enforcement actions, and appeals against executive orders of RBI. These are ex-ante mechanisms to ensure that each function is discharged as per process and rule of law.

However, the power to "recommend" demonetisation is neither a quasi-legislative power nor an executive or quasi-judicial power. Hence, these ex-ante mechanisms built in IFC may arguably have not been applicable to the proposal.

Ex-post accountability mechanisms generally perfrom the function of auditing performance and conduct. Table 6 gives a comparative overview of other accountability mechanisms that would have been applicable in the exercise of a recommendatory power.

Table 6: Internal accountability mechanisms
Feature Under the RBI Act Under IFC
Is the RBI board bound to have its own performance audited? No. Yes, by an internal audit committee comprising of atleast two independent members.(Section 39, IFC)
What does the internal audit include? NA (a) Whether the RBI is functioning in accordance with applicable laws, (b) Whether the bye-laws governing internal processes of the RBI promote transparency and best governance practices, (c) Whether the RBI is complying with the decisions of the RBI Board, and (d) Whether the RBI is managing the risks to its functioning in a reasonable manner.
Is the RBI Board bound to set parameters for measuring its own performance at regular intervals? No. Yes (Section 42, IFC)
Are the results of the audit, paramaters for measuring performance and their results, published? NA Yes, alongwith the annual report of the RBI (Section 43, IFC)
External accountability mechanisms
Are the financial statements of RBI audited by an external auditor? Yes, by auditors appointed by the Central Government (Section 50, RBI Act) Yes (Section 44, IFC)
Is the performance and efficiency of the RBI reviewed by an external team? No Yes, the performance and efficiency of RBI is reviewed by a team of external experts every three years (Section 45, IFC)

Tables 6 shows that the RBI Act does not compel RBI to maintain any internal accountability or other mechanisms to review its own efficiency and performance. More importantly, the law does not mandate RBI to set goals or parameters against which its performance can be measured. IFC has, on the other hand, built in internal review and performance-setting obligations against which the regulator as well as external observers can measure its performance.

Transparency of proceedings of the RBI board: RBI Act vs. IFC

Finally, ex-post accountability is greatly strengthened by transparency requirements. Table 7 gives a comparative overview of the transparency requirements imposed on the RBI, under the RBI Act and the IFC

Table 7: Transparency of meetings of the RBI board
Feature Under the RBI Act Under IFC
Is the agenda for a meeting of the RBI board to be published? No. Yes, within 3 weeks of the meeting (Schedule 2, IFC)
Are the minutes of meetings of the RBI Board required to be published? No. Regulation 8 of the RBI General Regulations, 1949 requires the proceedings of meetings of the RBI board to be circulated to the board members. Yes, within 3 weeks of the meeting (Schedule 2, IFC)
Are the votes casted by the members of the RBI Board at a meeting to be published? No Yes (Schedule 2, IFC)
Is there flexibility for redacting parts of the minutes of meetings before publishing them? NA Yes, on grounds listed in the law (such as where such publication can significantly frustrate the implementation of an action proposed by the RBI board)
Is there a process for deciding which portions of the minutes ought not to be published? NA Yes, reasons for not publishing must be recorded at the meeting, voted upon by a majority of the members of the Board and the vote of each member on the proposal to redact or not publish, must be published.
Do redacted portions of minutes ever get published? NA Yes, within six months, or as soon as the reasons for their delay cease to be applicable, whichever is later.

The main takeaways from Table 7 are that while one has to rely on the RTI Act to obtain a copy of the minutes of the board meetings of RBI. Application under RTI involves a monetary and non-monetary cost, and such attempts could fail. IFC mandates publication of the minutes, on an automatic basis, including in particular votes casted by members.

War-gaming demonetisation under the IFC

The comparative overview given above should help visualise how the recommendation to demonetise currency might have unfolded under the FSLRC framework. We attempt to do this through a prism of questions and answers.

Table 8: Visualising the role of RBI in the demonetisation decision under the FSLRC framework
Question Under the RBI Act Under IFC
Is the recommendation of the RBI Board required for the Central Government to issue a notification demonetising currency? Yes Yes
Is the RBI bound to honor the promise on the currency that has been demonetised? RBI Act is silent Yes (Section 278, IFC)
Could the quorum for the meeting where the demonetisation proposal is taken up, be constituted without the presence of independent members? Yes Yes
How many seats were vacant when the decision to recommend demonetisation was taken by the RBI Board? 11 NA
Was there a time-limit for filling up the vacant positions of independent directors on the RBI Board? No Yes (See Feature 1 of Table 3)
Does the law obligate the Central Government to report reasons for not filling up casual vacancies? No Yes (See Feature 2 of Table 3)
Is the RBI bound to publish the manner in which the members who attended the meeting, voted? No Yes (See Table 7)
Is the RBI bound to publish the agenda and minutes of the meeting? No Yes (See Table 7)
Will there be an internal audit of whether the RBI breached any law in making the recommendation to the Central Government? No Yes (See Table 6)
Will there be an external audit of the performance and efficiency of RBI in replacing the currency notes? No Yes (See Table 6)
If the RBI board did not recommend the demonetisation, could the Central Government have compelled it to do so? Yes, by exercise of its powers to issue directions, supersede the board or removal of members. No, as it does not have the power to issue directions or supersede the board.(See Table 5)


Post demonetisation, the discourse on RBI board governance has focused on either the independence of RBI or the conduct of former Governors or the present Governor. This is problematic, as it misses the woods for the trees. The demonetisation event has shown us that neither sheer board strength nor a brute majority of independent directors, can ensure regulatory independence.

Independence, accountability and transparency are intrinsically linked. The fact that the conduct of board members at meetings, together with details of who voted in what manner, will be published, incentivises people to vote responsibly. Hence, any argument for autonomy is rather incomplete unless it simultaneously asks for transparency and accountability.

A good fallout of the demonetisation event is that it has re-invigorated debates on regulatory governance and its importance on outcomes that we generally underplay India. We must not waste this opportunity and the lessons learnt to continue our reform agenda on regulatory governance.


Ila Patnaik and Shubho Roy, The RBI board: Comparison against international benchmarks, Ajay Shah's blog, January 24, 2017.

Bhargavi Zaveri is a researcher at the Indira Gandhi Institute of Development Research, Mumbai.

1 comment:

  1. Ajay, your comments add up to only one thing - that the decision was made and pushed down the RBI's throat. But I think that the public at large, and definitely the readers of your blog, already knows that. To me, we need bureaucrats and office bearers with spine. People who are willing to stand up to decisions being pushed down their throat. Till that happens these things will keep on happening. I take your exercise to show that law can help bureaucrats develop a spine.... but I think no one is ready to stand up yet. In the absence of the will the laws are meaningless. Very well researched piece but, with full respect to you and your team and all the authors mentioned here, in the absence of desire to stand up laws are just words on paper. Best Regards,


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