Who would audit the RBI?

 ET :KP Krishnan:June 6,2013

Two weeks ago ET reported that the Government of India had appointed two auditors for the RBI. The report also mentioned that this was done without consultations with the RBI.

 At one level this may be dismissed as trivia, of interest only to auditors and government servants. 

On deeper reflection it will be obvious that audit of regulatory agencies is more than a routine certification of balance sheets and is, in fact, an important mechanism for regulatory accountability.

The main activity of governments is to raise resources by tax and non-tax revenue measures and spend these for fulfillment of public policy objectives. 

Democracies like India have to do this within the framework of the rule of law established by the constitution. A major pillar of this framework is that ordinarily no department or agency charged with raising resources can appropriate it or a part of it for its own expenditures.

 For instance, the income-tax department cannot use the resources it raises for payment of salaries of its officers. Such expenditures have to be met out of budgetary allocations made to the department by Parliament. 

The logic is obvious. Agencies endowed by law with powers to raise resources should not have perverse incentives to mulct resources from citizens.

The Exceptions

Statutory regulatory authorities (SRAs) are an exception to this rule. SRAs like RBI are empowered by law to impose fees and to retain and use them for their expenditures.

 This exception is justified on the larger ground that the independence of SRAs is an equally important public policy goal. 

One important aspect of independence is the ability to raise resources to carry out functions conferred on the SRAs. Here is where "audit" plays a critical part.

Given the potential perverse incentives in this arrangement of an SRA raising and using resources, it is audit by a credible and empowered agency that can ensure that SRAs are acting as per rule of law. 

This means raising resources in a lawful, fair and equitable manner and spending them for the fulfilment of the objectives for which the SRA was created. Raising excessive resources and squandering them is not unknown and audit is a mechanism to check and curb this problem. In fact, an embarrassing accumulation of riches by excessive ad valorem fees on regulated entities by an Indian SRA led the board of the SRA to cut down on these fees drastically in 2008.

It is for this reason that most SRAs in India are mandated by law to be audited by the CAG. There are, however, notable exceptions and the pre-Independence SRA, RBI is one such organisation. 

The law says that ordinarily RBI will be audited by two auditors appointed by the GoI. It also says that the GoI may at any time appoint the CAG to examine the accounts of the RBI. 

However, this has never been done and the practice is chartered accountant firms audit RBI. Clearly, this is an unsatisfactory arrangement. It is unlikely that any private auditor will have the courage to point out problems, if any, in the finances and expenditures of RBI.

The Solution

It is for this reason that the Financial Sector Legislative Reforms Commission (FSLRC) has recommended in section 3.6 of its report that the financial accounts (of all financial regulators) shall be audited by CAG.

It is important to note that audit of SRAs is specialised and different from audits of government departments. Hence, teams undertaking this need to be fully equipped and trained. Otherwise we could potentially get into difficulties.

 A couple of years ago CAG insisted that SRAs cannot keep their fee incomes in separate accounts and that they should deposit these in government accounts.

Besides being regressive, this recommendation is contrary to the law. Fortunately some workable solution seems to have been found. 

But these dangers are real and persistent, so the best long-term solution will be to legislate with clarity as recommended by FSLRC.

The author is a government servant. Views are personal.