The Reserve Bank of India (RBI) deputy governor
Viral Acharya’s speech has attracted much media attention, but probably the core issues the central bank is raising has not got the attention it deserves.
Firstly, there is much angst on why spill the beans in public and why not discuss them privately. It must be obvious to all RBI-watchers that the current regime, if anything, has so far preferred to keep a low profile and speak very little publicly.
If the RBI top brass is airing issues publicly, it has to be assumed that it tried hard to resolve issues privately but couldn’t convince the government of its point of view. And because some of these issues are important for the country and for future generations, the RBI decided the people ought to have a chance to decide.
Two issues deserve the nation’s attention:
First is the dividend to be paid by the central bank. It must be remembered the RBI is not any bank or company. It is the central bank. It can’t be judged by the accounting standards of normal companies.
The RBI balance sheet should be such that it inspires the confidence of global investors. Also, the trust of global investors in the central bank’s balance sheet is tested most when the government is in peril, when its fiscal and/or current account deficits are high and when there is a run on the currency.
A government looks to its central bank usually when it is in a financial problem. It is important, therefore, that it keeps its central bank’s balance sheet worthy of triple A rating.
The RBI’s equity capital is a mere Rs 5 crore. The bank's strength is its reserves of about Rs 10 lakh crore. Of this, Rs 7 lakh crore is due to the revaluation of the gold and foreign exchange that it holds. Then, the RBI has Contingency (& Asset Devt) Reserves of Rs 2.5 lakh crore which is the sum total of the profits it has made over the last many decades.
Adding the revaluation and contingency reserves, RBI has a total capital of about 10 lakh crore or 27 percent of its balance sheet, which former chief economic adviser (CEA) Arvind Subramanian said make it one of the most highly capitalised central banks in the world.
Some central bank watchers disagree. They say the capital of central banks of countries with current account surpluses can’t be compared with countries which perennially run current account deficits and which bridge their deficit with foreigners bringing capital flows. Foreigners bring in dollars when they have confidence in the exchange rate and the ability of the central bank to steady the exchange rate during a crisis.
Coming to the reserves, most experts agree that the revaluation reserve should not be touched since it moves with the market value of the foreign exchange and gold reserves of the RBI. It is the contingency reserves (which is the sum total of retained profits over the years) that the likes of Subramanian believe, ought to be returned to the government or used for public purposes like capitalising banks.
At least three committees (including one led by YH Malegam) that went into the issue of reserves have held that RBI cannot do only with revaluation reserves, but must also have contingency reserves between 8 and 12 percent of its balance sheet. The current contingency reserve of Rs 2.5 lakh crore form 7 percent of its balance sheet.
Now should the NDA government be allowed to demand this amount?
Firstly, an extraordinary act of reducing the RBI’s reserves accumulated over the 2-3 decades, ought not to be taken by the government of the day. It should be gone into by a well-regarded committee of central bankers, statesmen and economists and their conclusions nationally debated.
Secondly, such a decision should best be taken at the start of a new government rather than by a government that is six months from completing its term.
Finally, decades of retained profits can’t be spent by one government that is about to go to polls. In all fairness, it should be spread over several years, probably by adjusting against the government bonds held by RBI. Ideally, this fund may even be used to smooth out dividend payments, which again should be decided by a committee comprising experts and leaders from the government and the opposition.
From the tone of the RBI DG’s speech, it appears that RBI is under tremendous pressure to hand over its surpluses squirrelled away over years and hence its decision to take the issue to the people.
The other key issue raised in the speech is the demand from the government to dilute the Prompt and Corrective Action (PCA) rules. Under RBI’s 2017 rules, banks whose capital falls below 10.25 percent, whose net NPA (non performing assets) is above 6 percent and which report negative return on assets for two 2 years or more are put under PCA.
Banks under PCA are restricted from lending to risky assets, that is to companies with a rating below A, until they bring down their net NPA to under 6 percent. The government has been arguing that world over banks are put into PCA only when their capital levels decline; other considerations like NPAs don’t figure.
The RBI’s argument is worth hearing out: Firstly, in most countries, banks are able to recover collateral from their defaulters in a few months. In India, the time taken to recover loans stretches from 4-14 years. On an average, only around 12 percent of the bad loans were recovered before the Insolvency and Bankruptcy Code (IBC).
Secondly, in most countries, banks have to provide 100 percent for a loan as soon as it is defaulted upon. In India, banks have to provide only 15 percent in the first year. Thus, by global standards, Indian banks are providing much less capital, especially when NPAs are high.
But that isn’t the nub of the argument. The problem is throughout 2017, thanks to demonetisation, banks were flooded with deposits but had little capital. So they lent easy loans to non-banking financial companies (NBFC), which in turn lent some of it recklessly to builders. Now as cash has become expensive, the NBFCs aren’t able to provide additional loans, leading to a fear that vulnerable builders and some SMEs may default.
Tug Of War
The tug of war lies here: RBI doesn’t want the already weak banks to lend to these risky entities. The government wants precisely that. A cornered central bank has brought the issue to the nation. So here’s what the nation has to decide: Should it allow one government with six months term left to take in all the accumulated profits of RBI (and possibly weaken it) and secondly should we allow the country’s already weak banks to lend more risky loans.Now can we say these issues aren’t worth being brought to the people?