Former Reserve Bank of India (RBI) governor YV Reddy weighed in on the central bank’s differences with the government over issues related to lending and liquidity, among others, raising concerns about the autonomy of the institution he once headed while acknowledging the supremacy of the government.
“The issues relating to the capital framework, the regulatory relaxations and the role and composition of the board will have a lasting impact on RBI,” he cautioned, delivering the
Kale Memorial Lecture at the Gokhale Institute in Pune on Friday.
The government and the RBI duelled publicly for months over relaxing lending rules, infusing more liquidity and allowing easier capital norms for banks to boost economic growth ahead of general elections due by May. The tussle ended only with the resignation of Urjit Patel as governor in December. His replacement Shaktikanta Das is widely perceived to be on the same page as the government on these issues.
On Friday, Reddy dwelled on the five critical contentious issues between the government and RBI.
On the government demands that RBI should relax the norms of Prompt Corrective Action for state-owned banks with high levels of bad debt and inadequate capital, he said in a manner, this dilutes both the autonomy and accountability of the central bank. “There can be genuine concerns of government, but governments generally persuade the regulator but not direct it in such matters.”
The RBI’s Prompt Corrective Action bars some state-owned banks from issuing fresh big-ticket loans or expanding operations. The financial performance of these banks is also closely scrutinised.
“Signals To The Market”
On the excess reserves in the balance sheet of RBI, Reddy said there is no doubt that in the ultimate analysis, the government as the owner has a claim over the reserves, but the way it exercises gives signals to the market and influences public opinion. The use of reserves will have to consider among others, factors such as the constitutional propriety of using them directly to fund capital of the banks instead of crediting it to Consolidated Fund of India and then using it as considered necessary by the government, and the incongruity of the banking regulator being asked to use its resources to fund banks that are in need of the capital, he said.
The government has been pushing the RBI to pay a higher dividend from its reserves to help fund the fiscal deficit, its argument being that the central bank’s surplus funds are higher than needed. The RBI under Patel resisted, saying that the funds provided insurance against sharp market turbulence.
On Friday, Reddy also argued in favour of RBI keeping the capital requirements of Indian banks higher than what Basel rules mandate. He pointed out that realisable [recovery] levels from bad loans in India are far lower than global levels and hence there is a “case for the Indian norms to be more stringent than global ones”. “But the scope, coverage and deviation from global standards are a regulatory and operational matter,” he said.
Reddy also put the spotlight on the government’s demand to facilitate lending liberally primarily to small and medium industries. Any extraordinary push will jeopardise depositors' interest or induce systemic instability, according to him. “This is a matter again in which government and the industry could raise the issues and convince the RBI, but should ideally respect the final judgement of RBI.”
On the friction between the government and RBI over the latter’s response to the liquidity conditions being faced by the non-banking financial companies, Reddy said RBI should be concerned at the risk assessment capabilities of public sector giants like LIC and SBI that allowed this to happen while having a large stake in the [troubled] Infrastructure Leasing & Financial Services (IL&FS).
Below are some of the highlights from his speech:
PCA Norms: "The government demands that RBI should relax the norms of Prompt Corrective Action... There can be genuine concerns of government, but governments generally persuade the regulator but not direct it in such matters. Obviously, the government is tilting in favour of their own regulated entities who failed to convince the regulator in the matter... In a manner, this dilutes both the autonomy and accountability of RBI." BASEL-III Norms: "In general, the Basel III norms assume a particular level of realisable value of the assets in case it becomes non-performing. In India, the transactions cost and the liquidity in relevant markets, in particular in real estates, make the realisable value generally far less than the declared value. There is, thus, a case for the Indian norms to be more stringent than global ones." IL&FS and NBFC Troubles: "If IL&FS faced a liquidity problem it would have been the responsibility of RBI. Obviously, it is an insolvency issue since the Government intervened. Perhaps, Government intervened since both LIC and SBI owned by it are large stakeholders in IL&FS, and also because many infrastructure projects are involved. In any case, RBI should be concerned at the risk assessment capabilities of public sector giants like LIC and SBI that allowed this to happen while having a large stake in IL&FS." SME Lending: "The government seeks a policy and a procedure from RBI to facilitate lending liberally primarily to small and medium industries. The SMEs problem is not new, nor is it unique to India. However, any extra-ordinary push will jeopardise depositors' interest or induce systemic instability. This is a matter again in which Government and the industry could raise the issues and convince the RBI, but should ideally respect the final judgement of RBI. To implement any support beyond what RBI considers it to be prudent, Government should ideally draw upon its budgetary resources as is being done in case of waiver of farmers loans."