The Reserve Bank of India Headquarters in New Delhi (Photographer: Kuni Takahashi/Bloomberg)

RBI Defends Its Capital Regulations Amid Differences With The Government 

The Reserve Bank of India has once again defended its policies in the public domain amid a standoff between the central bank and the government.

Differences ranging from the government's demand for more flexible regulations, including relaxing the prompt corrective action norms, to the RBI’s opposition to a separate payments regulator, have put the spotlight on the dynamic between the two institutions.

In the most recent case, RBI Deputy Governor NS Vishwanathan defended the regulator’s strict capitalisation norms and its adherence to the internationally-accepted Basel guidelines for banks.

“A strong and stable banking system is essential for the development of the economy. This strength should be real and inherent,” Vishwanathan said at a lecture at XLRI, Jamshedpur, a copy of which was reproduced on the RBI website. “The real strength will come from recognising weaknesses in the balance sheet and making provisions for them rather than pretending to believe that the balance sheet is strong.”

The RBI is in the process of adopting the the Basel III guidelines in a phased manner. The implementation of the global framework on bank capital adequacy will be fully done by March 31, 2019. Currently, Indian banks have to maintain a minimum common equity tier ratio of 5.5 percent and a total capital ratio of 10.875 percent which will go up to 11 percent when the norms are fully implemented. This means banks have to set aside a certain amount capital as buffer against any sudden, unanticipated financial shock.

But the central bank has faced some opposition to these norms. RBI board director S Gurmurthy, who’s also affiliated with the right-wing Rashtriya Swayamsevak Sangh, has on numerous occasions said that the Basel norms are not suited for Indian banks.

Vishwanathan argued that if banks don’t maintain adequate capital then their losses can bleed into the deposits. “Banks have to maintain adequate capital to ensure that the probability of deposits being eroded is close to zero.”

He said that capital regulations are “poorly understood” in India. He explained that it's misconception to see capital maintained by banks as some sort of a “rainy-day fund” and that keeping aside capital deprives the economy of money. “The reality couldn’t be farther from the truth—the capital maintained by banks would have already been deployed on its balance sheet towards creating assets, including loans.”

Prudential capital regulations aim to enable banks to sustain unexpected losses without defaulting on its obligations, especially deposits, by maintaining adequate levels of bank capital.
NS Vishwanathan, Deputy Governor, RBI.

He said that higher capitalisation also has a stabilising effect on the macro-economy while also increasing the skin in the game for shareholders. “Raising capital does involve costs—there is no free lunch—but the costs to the economy are offset by the savings made in the form of potential losses avoided in averted banking crises,” Vishwanathan said.

He concluded by saying that cleaning up of the banking system is a work in progress which has started yielding results. He called for guarding against any push for dilution of the standards and norms which lead to cherry-picking and results in banks that are strong only in fiction, but not reality. “It's by resisting such temptations, I believe, we'll build a financial system that's lot stronger than today...”