After an unprecedented three weeks of acrimony, the government and the Reserve Bank of India (RBI) have stepped back from the brink and averted a further showdown.
The RBI’s press release after a nine-hour board meeting on Monday suggests that the impasse has been broken on some of the contentious issues and decisions are now in place. Where the two sides are still not in agreement, the board has put in place frameworks for further talks so that decisions can be reached.
On the whole, the government may not be too pleased with the specific outcomes.
The threat to the central bank’s capital reserves – and the government reportedly eyeing 3.6 trillion rupees (nearly US$50 billion) – may have subsided. RBI’s capital has been left untouched for now.
The 18-member board decided that the appropriate economic capital framework will be examined by an expert committee, the members and terms of reference of which will be jointly decided by the government and the RBI. Even if the committee finds that the RBI is over-capitalized, the Modi government may not be able to appropriate any of the “excess” reserves, as barely months are left in its tenure before the Election Commission is due to schedule the next Lower House polls.
State banks saddled with high debt
It was expected that the board, at the behest of the government, would prevail upon the central bank to loosen the restrictions it has set up, through the Prompt Corrective Action (PCA) framework, on 11 of the 21 government-controlled banks that are saddled with high unprovided bad loans or recurrent losses. The government is keen that the RBI lift some of the curbs on lending by these weak banks so that the flow of credit can improve, especially to medium and small enterprises.
But the central bank stood its ground on weak banks. The board has left the PCA norms unchanged. It decided to let the RBI’s Board of Financial Supervision (BSF) examine if the PCA framework needs tweaking. The BSF is a committee of the board chaired by the Governor. The Deputy Governors of the RBI are ex-officio members. One Deputy Governor, usually, the one in charge of banking regulation and supervision, is nominated as vice-chairman of the BSF.
Chances seem remote of the government getting its way with this committee headed by RBI Governor Urjit Patel.
No change on capital provisioning
The government would have liked to see the board advise the RBI to lower the minimum capital provision requirement for banks to 8% against the current requirement of 9%. The board refused to yield to this demand of bringing down the Capital to Risky Asset Ratio (CRAR) in line with the bare minimum levels prescribed by Basel III norms. The board decided to retain the CRAR at 9%. It did, at the same time, agree to provide another year for implementing the last tranche of 0.625% under the Capital Conservation Buffer (CCB) by one year (up to March 31, 2020), which the RBI may have announced on its own anyway.
Again, the central bank’s, and not the government’s, position prevailed. A cause for worry, though, is that a decision of such a nature has been taken by the board. Since conventionally, the board has performed more of an advisory, rather than a supervisory role, high functionaries of big business houses that are also borrowers from banks are appointed as its voting members. In the future, there is no guarantee that a board packed with corporate honchos would place their faith in the RBI’s conservative approach to capital adequacy for banks.
The RBI’s conservatism on this front, by the way, makes eminent sense. International norms may not apply in Indian conditions that are atypical at least on two counts: Loan recovery has traditionally been low, while resolution and insolvency mechanisms are relatively new. To what degree these will succeed in changing the corporate credit culture remains to be seen. Secondly, 70% of the banking sector is controlled by the government and state institutions are not run like private banks.
Finally, the board advised the RBI to design a scheme of restructuring for medium and small enterprise loans of less than 250 million rupees ($3.5 million), subject to conditions necessary for maintaining financial stability. So, the call is essentially still the RBI’s to make.
Govt concern about small business
The government is especially anxious that the struggles – especially after demonetization and the roll-out of the Goods and Services Tax – of this sector may hurt it politically in the ongoing assembly elections in five states and general elections in 2019.
The contentious issue of liquidity for shadow banks, the non-banking financial companies (NBFCs), remains unaddressed and is likely to be taken up in the next meeting of the board scheduled for mid-December. Complaints that non-banking financial companies are facing a liquidity crunch was discussed at length earlier at the last Financial Stability and Development Council meeting chaired by Finance Minister Arun Jaitley in Delhi.
Despite vigorous arguments, lengthy presentations and deep differences, the board chose to not put any of the matters to a vote. All of Monday’s decisions were taken by consensus.
The outcomes confirm that the government may have decided to not follow through with the Section 7 process under the RBI Act which would have allowed it to issue written directives to Governor Urjit Patel. The government’s calmer approach may have helped cool temperatures and avoid a situation that could have rendered Dr Patel’s position in the RBI untenable. It may even have opened up space for back-channel talks between the two sides.
In the run-up to the board meeting, Governor Patel, it was reported, had flown down to Delhi, where he met up with the Prime Minister and later also the Finance Minister. He is likely to have shared the RBI’s concerns with them, and taken on board their views, leading perhaps to better understanding of the matters on hand on either side.
Chances of further public spats are slim, but the RBI-government relationship is far from repaired.