RBI Governor Urjit Patel and Finance Minister Arun Jaitley.  (Source: PTI)

RBI And Government Find Some Common Ground, Experts Say

The Reserve Bank of India and the central government have managed to meet at a middle ground on some of the lesser contentious issues even if it meant delaying few key decisions, experts told BloombergQuint.

“It’s a good starting point,” said Ananth Narayan, associate professor at SP Jain Institute of Management and Research. “De-escalating the heightened tension which has been there in the whole system even when it meant kicking the can down the road on some of the contentious issues.”

After a nine-hour long meeting of its central board, the RBI said it will constitute a committee to examine the central bank's capital framework. The central board also agreed to extend the transition period for the full adoption of Basel III norms by one year to Mar. 31, 2020.

This is a good first step. This is the more smart and credible way forward.
Ananth Narayan, Associate Professor, SP Jain Institute of Management and Research

The decisions taken today are very “sensible” because the whole fight between the RBI and government had spilled over to the public domain, said CM Vasudev, former economic affairs secretary of India.

“These are day-to-day issues that the government and RBI wrestle with each other all the time because they have different perspectives,” Vasudev told BloombergQuint. “All in all, it's a very welcome move and the issues which had escalated so much are probably getting resolved in a professional way.”

Yet, there remains a lot of unresolved tensions. “While its good to see de-escalation the issues have clearly not gone away,” Narayan said. “We still don't know which quart-compromise the government and the RBI will agree upon. And we don't know if that section 7 sword is still hanging around.”

But in a sense this is good de-escalation. Rather than being in a situation where they were not even talking, hopefully, you get together in a committee, de-escalate the issue, get this news off the ping press, do it behind closed doors and come with a sensible compromise somewhere.
Ananth Narayan, Associate Professor, SP Jain Institute of Management and Research.

On Deferring Basel III Implementation

The RBI deferring the full implementation of the globally accepted Basel III norms doesn't breach any norms because India was anyway doing it a year before, according to Saswata Guha of Fitch Ratings.

“At a more broader level, the signal it gives is that there is a severe capital problem in state-run banks,” Guha said. “We are in a situation where many banks are tethering at the brink of 5.5 percent minimum ratio. The question of them being able to meet the ECB (external commercial borrowings) without getting any significant capital injection was pretty much ruled out. Most of them were trying to keep their head above water.”

I don’t think it necessarily changes the capital requirement or the dynamics but by pushing it by another year, it gives banks more headroom to manage that extra capital. Where will the extra capital come from remains a big question.
Saswata Guha, Director (Asia-Pacific Financial Institutions), Fitch Ratings.

Narayan noted that this is the last tranche of 2.5 percent capital conservation buffer and it "makes sense" to add these in a counter-cyclical fashion. “When things are good, you add to your buffer. Things are not that great at this point so rather than being pro-cyclical, it was expected to get some leeway for another year,” he said. “They have merely preponed (advanced) it.”

On MSME Restructuring

The central bank's board has also agreed to “consider a scheme for restructuring of stressed standard assets of MSME (micro, small and medium enterprises) borrowers with aggregate credit facilities of up to Rs 250 million, subject to such conditions as are necessary for ensuring financial stability”.

“It's forbearance,” said Guha. “The definition of whether it’s forbearance to the extent we've seen earlier comes down to how prudently one actually enforces these mechanisms.”

In the past, Indian banks have used restructuring in a rather less prudent way. It has forced RBI to eventually do away with restructuring. Restructuring is the call of the hour. But, it signifies two things: it validates the stress that has been in the SME space, particularly post-demonetization. It also shows how banks go about implementing it.
Saswata Guha, Director (Asia-Pacific Financial Institutions), Fitch Ratings.

Abizer Diwanji of EY India agreed that it's indeed forbearance that the system can accommodate. "We have much larger issues to deal with. Banks will be wary of lending further money," Diwanji said. "Banks are so enamoured with the NPA problem, they are being more conservative."

The restructuring will not apply to the SMEs that are fundamentally unviable and instead focus on those that were hit hardest by the twin shocks of demonetisation and the Goods and Services tax, Vasudev said. “It has affected their viability and their accounts have become NPA for these type of reasons but their underlying viability remains strong,” he said. “That little bit of leeway is a recognition of reality on the part of RBI.”

On PCA Framework

No immediate change has been made regarding banks under PCA (prompt corrective action) framework, but the RBI board said in its statement on Monday that the matter will be examined by its Board for Financial Supervision.

But, Vasudev said, to expect public-sector banks that form 20 percent of the banking space, to only take deposits and not lend is only going to hurt them more. “I think you are sucking up more liquidity and making these banks more sick,” he said. “Probably what RBI is wanting the government to do is to put in more capital as owner of the banks.”

Diwanji said that the PCA criteria for lending set by the RBI is fair. “Their own underwriting is currently suspect which is why you have the NPA problem,” he said. “There are better banks which can lend. We need to focus on banks which are not in the PCA and figure out why they are not able to manage. If liquidity is the issue then provide it to them.”

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