When we think about central bank functions, it is important to know that their functions are governed by an Act/Law etc. The act determines what a central bank should do, objectives etc. This is because central banks are created by governments and legislation is a way to tell the bank what to do and what not to do.
This struck me when I was reading RBI’s Oct-2009 Monetary Policy review. Like all other central banks, RBI had started various facilities to help housing finance companies, non-banking finance companies etc etc. As crisis has eased, RBI has decided to unwind these facilities. The statement however added this legal angle:
As indicated in the Annual Policy Statement of April 2009, the following liquidity facilities provided by the Reserve Bank to banks and financial institutions are available up to March 31, 2010: (i) the export credit refinance (ECR) facility (limit up to 50 per cent of eligible outstanding rupee export credit) under Section 17(3A) of the Reserve Bank of India Act (RBI); (ii) the special refinance facility for scheduled commercial banks [limit up to one per cent of net demand and time liabilities (NDTL) as on October 24, 2008] under Section 17(3B) of the RBI Act; (iii) special term repo facility to scheduled commercial banks for funding to mutual funds (MFs), non-banking financial companies (NBFCs) and housing finance companies (HFCs) [limit is in terms of relaxation in the statutory liquidity ratio (SLR) up to 1.5 per cent of NDTL]; (iv) refinance facility to Small Industries Development Bank of India (SIDBI), National Housing Bank (NHB) and Export- Import Bank of India (EXIM Bank) [under Section 17(4H), Section 17(4DD) and Section 17(4J), respectively, of the RBI Act]; and (v) the forex swap facility to banks for tenor up to three months.
We usually just read about these facilities and that is it. But RBI tells you that all these facilities are under some section of RBI act (in this case Section 17). I was just seeing the RBI act and in it section 17 is Business which the Bank may transact. Though I don’t understand legal stuff, just a quick scan helps. It tells you RBI has not taken these actions randomly but the act allows it to. So, if RBI is doing anything, it is following some part of the act.
Similarly, when Fed intervened to help AIG, Bear Stearns it took help of Section 13 in its act. Minneapolis Fed research note even calls it history of a powerful para:
When the Federal Reserve Board authorized the Federal Reserve Bank of New York to lend $29 billion to JPMorgan Chase in connection with its purchase of Bear Stearns, much was written about why the Federal Reserve took such an action, and appropriately so. That discussion will likely ensue for many years. However, little attention was focused on how the Federal Reserve was able to take such action; that is, by what legal authority did the Federal Reserve intervene in the business of a nonbank (in this case an investment firm).
The broad answer to that question is the obvious one—the Federal Reserve Act provides such authority. The specific answer is Section 13 paragraph 3 of the Act, which begins: “In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may …,” and then there’s a lot of technical language which essentially means that the Federal Reserve can lend money to “any individual, partnership, or corporation,” as long as certain requirements are met.
Fed cleverly used this tool to support the fin firms. Minus this, it could not have and would have to take special permission from US Treasury.
Now there are questions about defining this section properly yo understand what it can do and not do. Again the changes will have to be made in the Act.
All this points to the importance of knowing central banks acts. It is all written there.